Sunday, May 10, 2015

Frank Newman: Provincial headwinds

Last month the Governor of the Reserve Bank announced the overnight cash rate (OCR) would remain unchanged at 3.5%. There were no surprises in that, but the commentary surrounding the six weekly review was less bullish about the next change being a rise.

Dr Wheeler said, "The timing of future adjustments in the OCR will depend on how inflationary pressures evolve in both the non-traded and traded sectors.  It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target... The Bank expects to keep monetary policy stimulatory, and is not currently considering any increase in interest rates."

The possibility of lower interest rates for longer has intensified competition in the banking sector. The Co-operative Bank recently reduced its 18-month fixed rate mortgages from 5.49% to 4.99%,  and both Kiwibank and ASB have cut their three-year rates to 5.39%.

The underlying message is banks want your business so don't be afraid to negotiate. If you are not getting the best rate, ask your bank to match it, and if you are a good customer you should be getting a better deal than their advertised rates. 

The economy itself is a dichotomy, or a trichotomy: Auckland, Christchurch, and everywhere else.

Auckland is experiencing its own property bubble, driven by constrained land supply and high demand for housing by immigrants. It is also now being driven by a significant speculative element which is creating increased concern.  A sure sign of the bubble was an article appearing in a recent property magazine about a young chap who is making his fortune with a strategy of putting $5,000 down on a yet to be built house and on-selling before final settlement is due on completion. Having made $20,000 on the first deal, he has scaled up with three more $5,000 deals. This scenario invariably ends badly for those who join the racket near the end of the cycle. Like the kids party game pass the parcel, they end up holding the parcel when the music stops - in the property game it’s a large parcel of debt they are unable to repay. Some are getting wise to the risks in the market and now looking for investment opportunities elsewhere, but this has not yet gained sufficient traction to ignite provincial property prices and counter the economic headwinds.

In the rural areas farmers are doing it hard. Fonterra has again cut the forecast farmgate milk price, this time from $4.70 per kilo of milksolids to $4.50. With a forecast dividend of 20 to 30 cents a share, the cash payout for the season is likely to be no more than $4.80, compared to a total payout of $8.50 per kilo of milksolids last year. It is expected that most farmers will have negative cash flow and will be forced to cut spending. How tightly farmers are gripping their cheque books will become evident at the annual Mystery Creek field days on 10-13 June.

For regions like Northland and Gisborne the news is worse as export log prices have fallen to a seven-month low. The average wharf gate price for New Zealand A-grade logs fell to $94 a tonne in April, from $106 a tonne in March. According to AgriHQ log piles on Chinese ports are reportedly close to 5 million cubic metres, more than double the normal level of around 2 million cubic metres. That excess stock is likely to take about a year to clear so low prices are likely for some time yet. The value of log exports slipped 13% to $3.5 billion in the year through March.

With lower dairy and log prices, it comes as no surprise that the government's books will not end up in the black for the current year as had been forecast, with much fanfare, in last year's budget. What was a $372m surplus is now likely to be a deficit of around $600m - a $1 billion turnaround. Clearly the lower tax revenue from the primary industry sectors is flowing through to the government coffers. .Finance Minister Bill English said this will not affect the government's spending programmes but will affect the debt repayment schedule, debt which was largely accumulated as an economic stimulus measure since the global financial crisis in 2008.

This year's budget will be presented to Parliament on Thursday the 21st of May. A small surplus is projected for the 2015/16 year.

Clearly there is a lot riding on the primary sector - for central government and local economies. 

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