Brighter new year looms

OPINION: This is my last column for the year – and what a year it has been. For the first two months the world economy faced a serious risk of a new Great Depression, writes Tony Alexander this week.

Although financial markets had opened up again after a few weeks of closure following the collapse of Lehman Brothers investment bank in the middle of September 2008, the impact on economic activity and willingness to spend after the tumultuous events of 2008 was looking extremely dire.

Data showed the likes of the Japanese economy shrank nearly 4 per cent during the 2008 December quarter, industrial goods orders to Asian countries plummeted, bank capital bases disappeared in the likes of the United States and Britain, unemployment rates soared and house prices collapsed in some countries.

Then the most significant period for this year came along. In the first week of March we heard talk about "green shoots". These were pieces of data showing still-falling retail spending, house prices and so on – so the term green shoots seems a bit strange. However, the data showed these things falling away at a lesser rate than in earlier months. That meant we were seeing evidence that the huge stimulatory measures undertaken by central banks and governments were having an effect. It was sort of like seeing the speedometer creep back from 140kmh to 138kmh . You are still in very bad territory, but starting to become less bad.

The green shoots produced huge changes in financial markets because they said to investors that one no longer needed to shift funds around to position for a depression, but instead one could start positioning for the eventual return of growth – even though no-one had any idea when growth would return in any country or how strong it would be.

This meant investors started putting money back into shares and sharemarkets have soared. Investors in low interest rate countries started looking for slightly higher yielding currencies – so the New Zealand dollar has soared.

Investors also started anticipating central banks raising their unusually low interest rates and that pushed up the returns they were demanding for investing over long time periods.

Fixed interest rates therefore soared while floating rates stayed low. More recently growing belief in global recovery has pushed New Zealand export commodity prices up over 30 per cent since early in the year, consumer and business confidence measures have soared, and of course the housing market has improved substantially after having only the mild downturn, which we had long predicted.

But it is not all sunshine and roses from here on. Although our trading partners are forecast to grow above 3 per cent on average next year, there is considerable uncertainty surrounding how central banks will raise interest rates without spooking economies, and how governments will move to get fiscal policies back in order. We are uncertain to what extent householders overseas have permanently changed their spending and saving habits, and it is not clear when banks in Britain and the US will become more willing to lend again.

But there is upward momentum and for us that means improving retail spending through 2010, rising house construction and of course house prices, improving manufacturing (assisted by the new boom in Australia), and employers looking more aggressively for staff.

Watch for the labour market to improve more quickly than many assume, and keep an especial eye on the May Budget. Hopefully we may see some tax reform to go alongside the yet-to-come spending cutbacks.

Merry Christmas to everyone.

» Tony Alexander is the chief economist for the Bank of New Zealand.

- © Fairfax NZ News

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