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P 280227Z JAN 08
FM AMEMBASSY WELLINGTON
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RUEHBY/AMEMBASSY CANBERRA PRIORITY 5077
RUEHUL/AMEMBASSY SEOUL PRIORITY 0282
RUEHKO/AMEMBASSY TOKYO PRIORITY 0682
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RUEHDN/AMCONSUL SYDNEY PRIORITY 0630
RHHMUNA/CDR USPACOM HONOLULU HI PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 0210
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS SECTION 01 OF 02 WELLINGTON 000020 
 
SIPDIS 
 
SIPDIS 
 
EAP/ANP, EEB, INR, STATE PASS TO USTR, PACOM FOR 
J01E/J2/J233/J5/SJFHQSTATE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PGOV NZ
SUBJECT: NEW ZEALAND REACTS CAUTIOUSLY TO U.S. ECONOMIC 
DOWNTURN 
 
 
¶1. Summary:  New Zealand politicians along with its Reserve 
Bank reacted cautiously last week to the news of a possible 
downturn in the U.S economy and its potential impact on the 
New Zealand's economy.  Attempting to soothe the concerns of 
the equity and export markets, the Prime Minister and the 
Finance Minister tried to reassure the public that NZ was on 
safe economic ground and its fiscal and monetary policies 
were capable of adjusting to any nearterm challenge.  The 
Reserve Bank of New Zealand (RBNZ) continues to see inflation 
as the greatest foreseeable threat to the NZ economy and 
decided to keep pressure on inflationary forces by continuing 
to maintain its tight monetary controls (i.e., highest in 
industrial world.)  Several New Zealand economists are also 
proposing that the Asian economies, which have generated most 
of the world's growth in recent years, have enough momentum 
of their own to shrug off at least a short drop in NZ exports 
to the U.S. End summary. 
 
GNZ Officials Downplay Negative U.S. Economic News 
--------------------------------------------- ----- 
 
¶2. Reacting to a two-week downturn in New Zealand's equity 
markets and fears of a possible recession in the United 
States, Prime Minister Helen Clark last week publicly 
extolled the resilience of the New Zealand economy to help 
ease investors' jitters.  The New Zealand Stock Exchange's 
(NZX) index of its top 50 domestic companies, the so-called 
"NZX 50" finished last Wednesday in positive territory for 
the first time since its fright along with other world 
financial markets over recession predictions in the United 
States, closing eight points or 0.2 percent higher after 
Tuesday's initial dramatic losses.  The NZ Cabinet also 
discussed the turmoil on world markets at its first meeting 
of 2008 on Thursday (1/24).  Noting that the New Zealand 
market had reacted positively to the U.S. Federal Reserve's 
announcement of a rate cut, PM Clark said New Zealand was in 
good shape to weather this bout of international volatility. 
According to the PM, "the country had had years of good 
growth, low unemployment and skills shortages, and the net 
debt position was in 'very, very good shape', conditions that 
were the opposite of recession."  "And we're in a resilient 
position compared with where New Zealand has been in past 
periods of shock so we are not unaffected, but we are more 
resilient than many," she said. 
 
¶3. Minister of Finance Michael Cullen has also been talking 
down any risks to New Zealand's economy, saying talk of 
global recession has been "over-hyped" and it is still too 
early to see what kind of impact the U.S. crisis might have 
for New Zealand.  Cullen has promised that the 2008 Budget 
will not include anything that might exacerbate domestic 
inflationary pressures.  If on the other hand the economy 
does take a downturn, the Finance Minister has at his access 
a budget surplus of NZ$1.5 billion (US$1.2 billion) worth of 
possible tax cuts as potential fiscal stimulus. 
 
¶4. RBNZ Governor Alan Bollard used his annual speech to the 
Canterbury Employers Chamber of Commerce on Friday (1/25) to 
reflect on some of the economic shocks New Zealand has had to 
contend with recently.  He attempted to ease market fears by 
saying the country is enjoying its longest (but not 
strongest) expansion since World War II, accompanied by low 
inflation which has averaged 2.2 percent over the past 10 
years but he cautioned that the reduced volatility in both 
prices and growth should not be taken for granted.  He 
maintained that the challenges the Reserve Bank faced today 
sprang in part from the growing importance of China, India 
and other rapidly industrializing countries in the world 
economy.  Their demand for fuel has seen oil hit US$100 a 
barrel this month and these higher oil prices have added 0.5 
percentage points a year to inflation since 2004.  The 
emerging economies' demand for oil is not the only factor in 
any new price shocks the Bank has had to think about - there 
is also the issue of "carbon pricing."  While acknowledging 
that much of the damage to the climate came from the 
accumulated stock of greenhouse gas emissions mainly from the 
advanced economies, it was the emerging economies which would 
contribute most to emissions in the future, Bollard said. 
The Government's principal policy to combat climate change is 
 
WELLINGTON 00000020  002 OF 002 
 
 
an emissions trading scheme which will raise petrol and 
diesel prices from the start of next year and electricity 
prices from 2010.  The bank estimates these measures will add 
0.25 percentage points to inflation next year and 0.35 in 
¶2010. 
 
¶5. In last Thursday's Monetary Policy Statement (MSP), the 
Reserve Bank of New Zealand (RBNZ) announced that its 
Official Cash Rate (OCR) would remain unchanged at the 
current level of 8.25 percent (one of the highest official 
rates in the developed world).  Dr. Bollard, in releasing 
January's MSP said, "on balance, the outlook for interest 
rates is little changed from the December, but the level of 
uncertainty in the economy has increased."  He further stated 
that, "although the consumer price index (CPI) level of 
inflation is expected to remain above 3 percent during 2008, 
we believe that the current level of the OCR remains 
consistent with future inflation outcomes of 1 to 3 percent 
on average over the medium term."  (Translation: RBNZ not 
likely to change OCR in the medium term in 2008.)  He based 
his opinion on the expectation that the New Zealand housing 
market will continue to cool and the labor market will remain 
tight at 2 percent unemployment, while domestic income growth 
is expected to remain strong, especially from dairy exports 
with core inflationary pressures still persistent.  The 
Governor took special note of the ongoing turbulence in 
international financial markets and deterioration in the 
outlook for the United States and European economies.  He 
said he will be watching these developments closely, 
particularly their implications for the Asian and Australian 
economies and their effect on world commodity prices. 
 
Strength of Asian Economies May Cushion New Zealand Economy 
--------------------------------------------- -------------- 
 
¶6. Brent Layton, chief executive of the New Zealand Institute 
of Economic Research said he remains optimistic for the NZ 
economy's prospects.  He maintains that the U.S. slowdown 
would not amount to a full-blown recession.  He is a 
proponent of the "decoupling theory" that proposes that the 
Asian economies, which have generated most of the world's 
growth in recent years, have enough momentum of their own to 
shrug off at least a short drop in NZ exports to the U.S.  He 
said, "I don't think Asia will slow a lot, hence the impact 
on Australia (NZ biggest trading partner) will not be so 
great, thus helping New Zealand."  "Share markets volatility 
reflected uncertainty," Dr. Layton said. "They were not 
always a reliable barometer of true economic outlook."  "It 
is only a very small proportion of the total value of 
equities that gets traded on any day," he said.  "You can 
have large movements which affect the value of the market but 
only a small proportion of players are participating."  Tony 
Alexander, chief economist of Bank of New Zealand is 
predicting the NZ economy will grow at a weak rate of below 2 
per cent this year.  Per Alexander, "there will definitely be 
an impact but there is some insulation," he said, citing the 
dairy boom, infrastructure spending, job security and wage 
growth, the prospect of tax cuts and level of businesses 
investing.  Any fall in local fixed-term mortgage rates would 
be limited, Mr. Alexander said, when U.S. interest rates 
began to rise again later in the year as concerns about 
inflation came to the fore again. 
 
¶7. Comment: The magnitude of the impact of a U.S. economic 
slowdown on New Zealand's economy will depend on how long it 
lasts and how much validity there turns out to be in the 
theory of "decoupling".  That is the extent to which the 
Asian economies, which have generated most of the world's 
growth in recent years, have enough momentum of their own to 
shrug off at least a short drop in NZ exports to the U.S.  If 
NZ is sufficiently "decoupled" from the U.S. market then the 
impact on commodity prices (particularly dairy), whose 
current strength underpins the growth prospects for New 
Zealand, should be modest. End comment. 
MCCORMICK