June 2005 Quarterly Review

WORLD ECONOMIC OUTLOOK

The world economic outlook remains positive according to the latest Organisation for Economic Development (OECD) and International Monetary Fund (IMF) forecasts.

Table 1: GDP Growth

	2006F	2005F	2004A
Australia - OECD	3.4%	2.5%	3.2%
- IMF	3.3%	2.6%	3.2%
New Zealand - OECD	2.4%	2.9%	4.8%
- IMF	2.6%	2.8%	4.8%
United States - OECD	3.3%	3.6%	4.4%
- IMF	3.6%	3.6%	4.4%
World/OECD - OECD	2.8%	2.6%	3.4%
- IMF	3.0%	2.6%	3.4%

The OECD forecasts were released in June and IMF in April.

Europe and Japan are experiencing low growth but the United States, Australasia and the rest of Asia are growing relatively strongly.

Both the OECD and IMF warn that there are a number of threats to world growth, including rising oil prices and the current account deficits in the United States and other developed countries.

The two agencies believe that world economic growth will ease from 3.4 per cent last year to 2.6 per cent in the current year but will pick up again in 2006.

NEW ZEALAND

The New Zealand economy has had a remarkably strong run since the beginning of the decade.

For the twelve months to March 2005 real GDP grew by 4.2 per cent compared with 4.8 per cent for the 2004 calendar year and 3.6 per cent for the twelve months ended March 2004.

As Table 2 illustrates real GDP growth has been in excess of 3.4 per cent, on an annual basis, since the beginning of 2002.

Table 2: New Zealand: Real Gross Domestic Product Growth

(Annual percentage changes)

Quarter	2005	2004	2003	2002	2001	2000
March	4.2%	3.6%	4.6%	3.5%	2.3%	5.2%
June		4.3%	4.2%	3.9%	1.9%	5.5%
September		4.7%	3.7%	4.5%	2.0%	4.7%
December		4.8%	3.4%	4.7%	2.6%	3.5%

GDP growth of 4.2 per cent in the March 2005 year was mainly due to strong domestic demand. Internal demand rose 6.8 per cent in the twelve-month period and, as a consequence, import volumes grew by 13.3 percent.

By comparison the performance of the export sector has been relatively weak. Export volumes rose only 2.9 per cent in the latest twelve months as dairy and forestry volumes declined.

The combination of a strong domestic economy, rising imports and low export volume growth is having a negative impact on the current account deficit.

Table 3: New Zealand: Current Account

(Twelve months ended 31 March 2005)

($million)	Receipts	Payments	Balance
Goods	31,091	33,526	(2,435)
Services	11,794	10,586	1,208
Investments	2,471	11,914	(9,443)
Transfers	1,441	1,117	321
Total	46,796	57,143	(10,349)

The deficit of $10.3 billion for the year to March 2005 represented 7.0 per cent of GDP.

The main contributor is the investment deficit. The $11.9 billion of investment payments comprises the interest payments on the country’s overseas borrowing and the earnings attributable to the overseas owners of New Zealand companies.

The profitability of overseas owned companies has risen dramatically in recent years because of the strong performance of the domestic economy.

Unless there is a reduction in the current account deficit it will put downward pressure on the New Zealand dollar over the medium to longer term.

AUSTRALIA

Australia’s real GDP increased by 2.7 per cent in the year ended March 2005 compared with 3.2 per cent in the 2004 calendar year.

Household expenditure has slowed to an annual rate of 3.4 per cent and this has begun to reduce import volumes. Nevertheless in the past twelve months import volumes rose 10.0 per cent whereas export volumes increased by just 2.7 per cent.

The boom in imports has had a negative impact on Australia’s current account deficit, which blew out to $57.1 billion or 6.3 per cent of GDP in the March 2005 year.

Table 4: Australia: Current Account

(Twelve months ended 31 March 2005)

($million)	Receipts	Payments	Balance
Goods	121,964	147,103	(25,139)
Services	35,124	36,249	(1,125)
Investments	18,943	49,409	(30,466)
Transfers	4,273	4,670	(397)
Total	180,304	237,431	(57,127)

The Australian economy is expected to pick up next year through a combination of booming mining exports and increased consumer confidence and expenditure.

UNITED STATES

The United States economy continues to perform relatively strongly as real GDP grew by 0.9 per cent in the March 2005 quarter, on a seasonally adjusted basis, compared with the December 2004 quarter.

The US economy has now experienced 14 consecutive quarters of positive economic growth. The major contributors to economic growth in the latest quarter were household expenditure, residential housing and exports.

Table 5: United States: Real Gross Domestic Product Growth

(Seasonally adjusted)

Quarter	2005	2004	2003	2002	2001	2000
March	0.9%	1.1%	0.5%	0.8%	(0.1%)	0.3%
June		0.8%	1.0%	0.6%	0.3%	1.6%
September		1.0%	1.8%	0.6%	(0.4%)	(0.1%)
December		0.9%	1.0%	0.2%	0.4%	0.5%
Annual		4.4%	3.0%	1.9%	0.8%	3.7%

GDP compared with the previous quarter.

The United States economy is expected to slow in 2006 but most economists are still expecting real GDP growth in excess of 3 per cent.

SHAREMARKETS

It has been another great year for the world’s sharemarkets, particularly in Australasia.

The MSCI World Gross Index rose 10.6 per cent in the twelve months to June 30 with the Australian sharemarket achieving an impressive 27.4 per cent gain in gross terms and the New Zealand sharemarket 18.7 per cent.

But the last six months has been volatile, particularly in New Zealand. The NZX had a negative return of 1.0 per cent for the March quarter but recovered with a positive return of 6.7 per cent for the June quarter. By comparison the ASX has been far more consistent. It had a positive return of 3.6 per cent for the March quarter and 5.2 per cent for the June quarter.

As Table6 indicates the NZX and the ASX continue to be two of the world’s best performing sharemarkets over the past one, three and five year periods. In the three and five year periods the NZX was in third place.

Table 6: Annualised Gross Sharemarket Returns

(local currencies)

(To June 30, 2005)

	1yr	3yrs	5yrs	10yrs
Australia	27.4%	15.4%	9.1%	10.9%
Hong Kong	26.8%	10.7%	3.2%	5.8%
Japan	0.1%	4.5%	(5.5%)	0.7%
New Zealand	18.7%	17.7%	10.4%	6.6%
United Kingdom	18.2%	6.8%	(0.3%)	7.5%
United States	7.0%	8.6%	(2.9%)	9.9%
World	10.6%	8.0%	(2.8%)	8.4%

Source: MSCI

In US dollar terms (Table 7) the New Zealand sharemarket was the world’s second best performing sharemarket, after the Vienna bourse, in the three and five year periods.

Overseas investors have done very well in this country and selling pressure occurs when foreign investors decide to crystallise their profits. This usually occurs when the NZ dollar comes under pressure and when negative statistics indicate that domestic economic activity is about to wane.

Table 7: Annualised Gross Sharemarket Returns (US dollars)

(To June 30, 2005)

	1yr	3yrs	5yrs	10yrs
Australia	39.4%	26.5%	14.4%	11.7%
Hong Kong	27.2%	15.5%	3.2%	5.7%
Japan	(1.4%)	7.3%	(6.4%)	(1.9%)
New Zealand	30.1%	32.7%	19.3%	7.0%
United Kingdom	16.8%	12.7%	3.1%	8.8%
United States	7.0%	8.6%	(2.9%)	9.9%
World	10.6%	10.6%	(1.6%)	7.5%

Source: MSCI

Earlier this year we predicted that the NZX and ASX would achieve gross returns between 10 per cent and 15 per cent in 2005. The NZX rose 4.7 per cent in the first six months and the ASX 9.3 per cent.

The Australian sharemarket should achieve our target forecast, particularly as its economy is expected to pick up next year.

The New Zealand sharemarket is more difficult to predict. The economy is weakening but the high level of corporate activity, mainly mergers, takeover offers and capital repayments, suggests that the NZX could surprise on the upside over the remainder of the year.

CURRENCY

The New Zealand dollar continues to perform extraordinarily well.

As Table 7 indicates the dollar has eased slightly against the US$ and Australian$ since the beginning of the year but it has risen strongly against the Japanese Yen, Euro and UK Sterling. The overall result is that the Trade Weighted Index has risen 2.9 per cent, from 69.0 to 71.0, since the end of 2004.

Table 8: New Zealand Dollar against Major Currencies

	30 June	31 December
	2005	2004	2003	2002	2001	2000
US$	0.709	0.711	0.654	0.526	0.415	0.440
UKStg	0.390	0.372	0.368	0.329	0.286	0.295
Aust$	0.924	0.934	0.874	0.931	0.812	0.794
Yen	77.01	74.32	70.05	62.44	54.53	50.32
Euro	0.583	0.532	0.522	0.502	0.470	0.473
TWI	71.0	69.0	65.2	58.8	50.3	50.5

Most of the major forecasting groups are expecting the NZ dollar to weaken before the end of the year as US interest rates rise and the Greenback firms.
In its June Monetary Statement the Reserve Bank had this to say about the New Zealand dollar:

“The TWI exchange rate is marginally higher than the level assumed in the March Statement. Our assumption is for the TWI to remain around its current level for some months before gradually reverting to its long- term average (about 60.0). The profile of the TWI is modelled to be consistent with the projected decline in world export prices and a narrowing in the short-term interest rate differential between New Zealand and the rest of the world.”

The Reserve Bank is forecasting the TWI to average 69.75 during the second half of 2005, 66.75 in the first half of 2006 and 64.25 in the second half.

FIXED INTEREST

New Zealand has traditionally had higher interest rates than the United States, particularly for short-term borrowings. The gap widened in recent years and is one of the major reasons why the New Zealand dollar has performed so strongly against the US dollar.

The gap has narrowed from 418 basis points in March 2003 to 287 basis points at the end of June 2005.

Table 9: One-Year Government Securities – NZ& USA

Date	New Zealand	United States	Difference
30/6/05	6.32%	3.45%	+2.87
31/3/05	6.47%	3.30%	+3.17
31/3/04	5.34%	1.19%	+4.15
31/3/03	5.42%	1.24%	+4.18
31/3/02	5.46%	2.57%	+2.89
31/3/01	5.76%	4.30%	+1.46
31/3/00	6.69%	6.22%	+0.47

The Federal Open Market Committee raised the federal funds rate from 3.00 to 3.25 per cent on June 30 and its discount rate from 4.0 to 4.25 per cent. The Committee said that it had raised interest rates because of the inflationary pressure caused by the strong US economy.

Higher US interest rates could have major implications for New Zealand financial markets.

The first impact would be to make New Zealand interest rates less attractive, which would encourage overseas investors and speculators to leave New Zealand and put downward pressure on the dollar.

This in turn would create inflationary pressure unless there is a corresponding slowdown in consumer demand at the same time.

OUTLOOK

The outlook for the world economy remains positive. New Zealand is expected to perform better than Australia in 2005 but the situation is expected to reverse next year.

The Australian sharemarket has performed slightly better than the NZX and this trend is predicted to continue until the end of the year. However a continuation of takeover and merger activity on this side of the Tasman will boost individual stocks and has the potential to have a positive influence on the overall market.

Inflation concerns have increased because of higher oil prices and the strong domestic economy. As a consequence the Reserve Bank will have to raise interest rates in the second half of the year unless economic activity eases.

The New Zealand dollar continues to be the biggest uncertainty. In the last two quarterly reviews we stated that a range between 60 and 65 cents to the United States dollar would be the best scenario for the New Zealand economy. Recent developments suggest that the New Zealand dollar could be within this range at the end of 2005.

Brian Gaynor