New Zealand Business Confidence Plummets in "Protest Vote" but Rebound in Confidence, Inflation and the NZ Dollar are Expected

The bigger picture is the NZD is oversold and inflation is rising toward its target, meaning markets could soon look for an interest rate rise from the RBNZ. 

Business confidence in New Zealand has fallen to its lowest level since shortly after the collapse of Lehman Brothers, and the height of the financial crisis, although strategists say the November survey result could be the business community’s very own protest vote.

The ANZ Business Confidence index fell to -39.3 for November, down from -10.1 in October, with the downturn in sentiment showing through across all segments of the survey and all sectors of the economy.

It is the first full month survey since the Labour led coalition government was announced on October 19 and marks the lowest ebb for NZ confidence since March 2009.

“A net 39% of businesses are pessimistic about the year ahead, the lowest [highest] level since early 2009, and a decline of 29 points from the previous month,” says Sharon Zollner, chief economist at ANZ Bank. “Headline business confidence is negative across all the five subsectors. It is weakest among agricultural firms, while the sharpest fall came in the retail sector”

October saw the New Zealand Labour Party emerge at the head of a new government after winning over kingmaker New Zealand First. Markets had feared this outcome the most given a wave of business-negative election pledges.

“We suspect there may well be a political protest-vote element in this month’s results,” says Zollner. “There is evidence that the gap between headline business confidence and firms’ own activity varies across the political cycle. The latter tends to align better with overall economic growth.”

These election pledges range from a clamp-down on migration, restrictions on foreign purchases of NZ residential property and reforms the Reserve Bank of New Zealand.

Promises of a higher minimum wage have also been a factor, which may explain why the retail sector underwent the sharpest fall in confidence of all in November’s survey.

Economy to weather the Storm

“The economy is at a delicate juncture as migration, construction and housing run out of steam as growth drivers. Commodity prices are strong and a fiscal boost will come through in time, but at such times of transition, sentiment is more vulnerable and a hiatus adds to the prospect of growth wobbles,” notes Zollner.

Zollner and the ANZ team say the NZ economy is likely to weather the dip in confidence, but flag the Reserve Bank of New Zealand and Treasury as being too optimistic in their forecasts for economic growth

“It seems fair to say that some of the new government’s policies will be a direct impost on private firms, especially those of small to medium size, and away from the major metropolis areas.The policy around the minimum wage is a good example of this.” says Craig Ebert, a strategist at Bank of New Zealand (BNZ).

The New Zealand minimum wage will rise nearly 5% in 2018, to $16.50 an hour, up from $15.75 in the current year. Further increases, taking it all the way up to $20, are pencilled in for the years to the end of 2021 following a coalition agreement.

“To be clear, we are not about to slash our economic growth forecasts – or anything else for that matter – on the basis of today’s ANZ business survey. However, its latest readings definitely make us glad we have kept our GDP forecasts on the conservative side for the near term,” chimes Ebert.

Rising Inflation brings RBNZ into Focus

While November’s confidence survey leaves many more cautious in their outlook for New Zealand GDP, most seem to agree inflation is likely to continue ticking higher during the months ahead, which is something that could have implications for RBNZ monetary policy and the Kiwi Dollar.

Central banks tend to raise interest rates in response to rising inflation, and a side effect of higher interest rates is a higher currency.

“Today’s news is no reason to back off our story of inflation picking up - something that the inflation gauges in today’s ANZ survey gave more life to, in fact,” says Ebert. “General inflation expectations also strengthened noticeably in today’s ANZ survey – to 2.34%, from 1.93% last month.”

With the New Zealand Dollar down around 6% against the greenback since October 19, and wages for the low-paid set to pick up over the coming years, the RBNZ is one of the few central banks in the developed world that is unlikely to have too much trouble meeting its inflation target.

“This was a common theme across the various sectors rather than isolated to one or two, says Ebert. “This, along with the behaviour in near-term pricing intentions, would seem consistent with the business cost pressures implied by new government policies, as well as the recent fall in currency (overlaid on an economy that is running at or near full capacity).”

New Zealand Dollar Oversold

Some have begun to flag the New Zealand Dollar as being oversold in the wake of the election, given the economy is near to its full capacity, inflation is rising and the central bank has kept the cash rate at its current 1.75% level ever since November 2016.  

“We are short GBP vs NZD right now in our model portfolio, mostly as we think the kiwi has found a floor after several weeks of relentless post-election selling,” writes James Rossiter, a strategist at TD Securities, in a note to clients.

Overnight Index Swaps markets imply there is a 90% probability the RBNZ will raise the cash rate around November 2018 but the TD Securities team say there is scope for this to be brought forward if the economy remains on a strong footing.

The Pound is also trading close to fair value while the Kiwi remains at a steep discount, according to Rossiter, which supports his call for a pullback in the Pound-to-New-Zealand-Dollar rate.

TD Securities recommended selling the Pound-to-New-Zealand-Dollar rate short from 1.9305, with a stop loss at 1.9620 and a target price down below 1.8696.

The stop loss was triggered Thursday morning after reports of further progress in the Brexit negotiations emerged, which sent the Pound higher against all of its major counterparts.  

Nonetheless, Rossiter has not been alone in arguing for a rebound in the New Zealand Dollar, as shift in positioning is now close to becoming a theme among strategists. 

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