NZI Bank sees risks ahead

Press, 1 March 1989, Page 42

NZI Bank sees risks ahead

PA Wellington NZI Bank predicts inflation down to 4.2 per cent for the year ended March 31, but a slow rise in the annual rate thereafter, with risks that a new Government policy emphasis on stemming unemployment will bring further inflationary pressure.

The bank’s March quarter “Economic Report” warns the coming year will test the Government’s ability to maintain the rate of inflation at or below the current level of 4.7 per cent. The bank predicts the annual rate will drift back towards 5 per cent by later this year, with risks of a higher rate.

“If the Government’s resolve becomes diluted and new economic targets are set, then the resulting loss of overseas confidence may also precipitate a fall in the exchange rate ... with serious inflationary implications.”

NZI Bank cites a redirection of economic policy towards fighting unemployment as the likely change that could threaten higher inflation. It says the price impacts of the exchange rate falls last August and since last October have yet to be fully felt in the inflation rate.

In addition, liquidity conditions in New Zealand had been on the “easy side of firm” since October and if this continues, further falls in interest rates will weaken

the exchange rate, unless the falls are “accompanied by a reduction in the real interest rate required by foreign investors.”

The bank gives an optimistic scenario on the economy this year based on a firming of monetary policy, achievement of the Government’s financial deficit target (a cut to 1 per cent of gross domestic product) and a restated commitment to economic policy reform.

With these would come inflation of about 3 per cent by March, 1990, mild appreciation of the currency and a gradual recovery in over-all activity. A pessimistic scenario rests on a continuation of “current comfortable liquidity conditions,” deterioration of the financial deficit to 3 per cent of GDP and a move towards creating growth in the economy in order to stem rising unemployment. NZI Bank says the result of these would be inflation back to 5 per cent for 1989-90 and a moderate consumptiondriven recovery which would not be sustainable.

The trend in interest rates will hinge on these two scenarios, with a more stable political environment and continuation of policies in line with the optimistic scenario being “paramount” if more big falls in long-term rates are to occur, the bank says.