VZCZCXRO2708
RR RUEHAG RUEHCHI RUEHDF RUEHFK RUEHHM RUEHIK RUEHKSO RUEHLZ RUEHNAG
RUEHPB RUEHRN RUEHROV
DE RUEHWL #0226/01 2032108
ZNR UUUUU ZZH
R 212108Z JUL 08
FM AMEMBASSY WELLINGTON
TO RUEHC/SECSTATE WASHDC 5332
INFO RUEHNZ/AMCONSUL AUCKLAND 1705
RUEHBY/AMEMBASSY CANBERRA 5217
RUEHDN/AMCONSUL SYDNEY 0696
RHHMUNA/CDR USPACOM HONOLULU HI
RUEHZU/ASIAN PACIFIC ECONOMIC COOPERATION
RUEHSS/OECD POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC 0240
RUEATRS/DEPT OF TREASURY WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE

UNCLAS SECTION 01 OF 02 WELLINGTON 000226 
 
SIPDIS 
 
STATE FOR EAP/ANP, EB, INR, STATE PASS TO USTR, PACOM FOR 
J01E/J2/J233/J5/SJFHQ 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: NEW ZEALAND ECONOMY FACING RECESSION WHILE BATTLING 
INFLATION 
 
WELLINGTON 00000226  001.2 OF 002 
 
 
Reftel: WELLINGTON 168 
 
¶1.  Summary. The recent slowdown in New Zealand's economy is the 
result of weaker private consumption growth, owing to higher fuel, 
food, utilities and housing costs, which are cutting into Kiwis' 
disposable income.  Both business and consumer confidence remains 
weak amid higher prices and rising unemployment.  Fixed investment 
is subdued as business confidence remains low.  Despite this 
weakening in the economy, the Reserve Bank of New Zealand (RBNZ) is 
expected to leave interest rates on hold Thursday (July 24), but a 
reduction of 25 basis points is possible within the next two months 
as the pressure of a stalling economy outweighs rising inflation 
concerns.  A survey of New Zealand economists indicates that the 
RBNZ Governor Alan Bollard will wait until the next full monetary 
policy statement on September 11, by which time he will have a 
better sense of market trends.  Meanwhile, the Finance Minister has 
limited fiscal stimulus options left to help stave off recession. 
End summary. 
 
Monetary Policy 
--------------- 
 
¶2.  Monetary policy has been on hold since July 2007, following a 
significant tightening that left New Zealand's interest rates among 
the highest in the developed world. However, the RBNZ, which targets 
an inflation range of 1 to3%, remains concerned about the outlook 
for price increases.  The RBNZ raised the overnight cash rate (OCR) 
by 25 basis points on four occasions in 2007, the most recent of 
which, in late July 2007, saw the rate increased to 8.25%.  RBNZ has 
pointed to the substantial inflationary risks that exist, notably 
rising oil and food prices, and medium term concerns about the tight 
labor market and high capacity utilization.  The RBNZ forecasts that 
year-on-year inflation will peak at 4.7% in September 2008 before 
slowing. 
 
¶3.  Local economists believe that the RBNZ will maintain current 
interest rates when it meets Thursday (July 24). ASB Bank economist 
Nick Tuffley predicted that a rate cut was unlikely.  "We don't 
think there has been sufficient easing on the non-tradable front to 
counter concern over high headline inflation," said Tuffley. 
Westpac chief economist Brendan O'Donovan has a gloomier prediction 
of inflation rising to 5.5% by the end of September.  "I think that 
there will be the peak so long as oil prices don't scoot even 
higher," he said.  O'Donovan said the RBNZ was in a tricky situation 
dealing with "stagflation," i.e., growth falling because higher 
costs are hitting household budgets while inflation is rising. 
Longer term, experts believe that monetary policy is likely to ease 
slightly by the third quarter of 2008 (September). 
 
Business Confidence 
------------------- 
 
¶4.  Businesses are the most pessimistic about their future than in 
26 years, according to July 2008 Quarterly Survey of Business 
Opinion (QSBO), which pointed to a recession lasting at least three 
quarters of the year.  A net 18 percent of firms reported a decline 
in their activity, and the same proportion also expected activity to 
fall in the next three months, as of the June quarter.  Those 
seasonally adjusted readings were the lowest since June 1998 and 
December 1982, per the NZ Institute of Economic Research (NZIER). 
NZIER economists predict two more quarters of economic decline are 
likely to follow the 0.3 percent fall in Gross Domestic Product 
(GDP) following the March 2008 quarter. 
 
Inflation and Looming Recession 
------------------------------- 
 
¶5.  Statistics New Zealand reported in July that inflation in New 
Zealand had jumped by its highest amount in 18 years during the June 
2008 quarter, up 1.6% to top 4% for the year.  It is the highest 
inflation has been since June 1995.  The consumer price index (CPI) 
and the food price index were at their highest quarterly levels 
since June 1990, led by increases in the price of petrol, groceries, 
utilities and housing costs.  The largest contributor to the 
consumer price index (CPI) rise was petrol, up 12.8% in the June 
quarter and by 25% over the past year.  Food was up 2.2% in the 
three months to June and by 8.2% over the past year.  Electricity 
was up 3.6% in the June quarter.  The rise in grocery prices was 
higher overall, up by 12% in the past year, led by significant price 
 
WELLINGTON 00000226  002.2 OF 002 
 
 
increases in dairy products.  Fresh milk rose 22% in price over the 
year, cheese 62% and butter 86.6%.  A loaf of bread was up 15.2%, 
fruit and vegetables 5.2% and fresh meat and poultry 4.8%. 
 
¶6.  Finance Minister Cullen reacted to the news by saying, "the CPI 
only confirms what New Zealanders already know - that the global 
commodity boom was putting considerable pressure on household 
budgets."  He went on to say, "it is important to remember that our 
economic challenges are not of New Zealand's making - the global 
increase in the prices of petrol and food are outside New Zealand's 
control." 
 
¶7.  The NZ Treasury's June 2008 Report states, "New Zealand may 
already be in recession experiencing a sharp slowing of growth in 
early 2008 and pointing to further weakness in the June 2008 
quarter."  Drought and weaker domestic demand saw the economy 
contract 0.3 percent in the first quarter, being the first quarterly 
fall since 2005 and larger than the 0.1 percent fall forecast in the 
government's May budget update.  However, the NZ Treasury said the 
economy could be expected to recover in the second half of the year 
under the impact of high dairy prices boosting farmer incomes and 
cuts to personal tax rates, which come into effect on October 1. 
 
2008 Budget/Fiscal Policy 
------------------------- 
 
¶8.  Finance Minister Michael Cullen announced a series of stimulus 
and tax cutting measures in this year's annual budget (see Reftel), 
which were calculated to regain voters' support.  The first tranche 
of tax cuts are programmed to take effect on October 1, 2008. 
(Note: Some prognosticators maintain that PM Clark will wait until 
November 8 to call elections allowing the benefits of the tax relief 
package to be more acutely felt by voters. End note.)  The tax cuts 
will equate to between NZ$12 (US$8.80) and NZ$28 (US$21) per week, 
depending on income level/tax bracket.  Corporate taxes were cut 
from 33% to 30% from April 1st 2008. Economists predict that the 
rising costs of living will leave the average Kiwi worse off than a 
year ago.  Despite the tax relief scheduled for October, the average 
New Zealand family will need NZ$57 more per week than last year to 
buy the same amount of goods. 
 
Comment 
------- 
 
¶9.  In the run-up to the general election, which is expected anytime 
between September and November 2008, the governing Labour Party is 
struggling to regain popular support against a contracting economy 
with high interest rates and rising prices.  These economic factors 
are likely to weigh negatively on the Labour Party's chances of 
re-election.  Meanwhile, the National Party appears to be in no 
hurry to reveal policy details on issues such as its proposed 
alternative tax cuts.  However, National will come under increasing 
pressure to outline a comprehensive economic policy laying out 
National's strategy for dealing with an economic environment that 
New Zealand voters consider the most the most decisive factor in the 
upcoming election. 
 
MCCORMICK