September 2007

GLOBAL ECONOMY

The outlook for the world economy remains positive even though rising interest rates are expected to have a negative impact on global GDP growth in 2008.

Table 1: Forecast GDP Growth

Source: The Economist

China and India continue to be the main driving forces behind the global economy.

As far as China is concerned a lower net export contribution will see GDP growth ease from an expected 11.4% in 2007 to 10.1% in 2008 and 9.2% in 2009. The Chinese government will continue in its efforts to rebalance the economy, attempting to make growth less dependent on exports and investment while introducing measures to boost consumption.

A boost in Chinese consumer spending in expected to compensate for higher interest rates and subdued retail trade in western countries. The outlook for the global economy remains positive as long as the Chinese economy maintains its high growth rate.

NEW ZEALAND ECONOMY
The New Zealand economy grew by 0.7% in the June 2007 quarter and by 2.2% for the twelve months ended June

Table 2: NZ GDP growth (annual)

The important point is that both the June quarter and June year GDP growth rates were slightly higher than most forecasts, including the more recent Reserve Bank of New Zealand projections.

This indicates that the Reserve Bank will not lower interest rates in the next six months as the bank’s pessimistic outlook on inflation is based on the expectation that economic activity would be lower than current levels.

NEW ZEALAND DOLLAR

The New Zealand dollar continues to be a dominant feature for most companies and investors.

Table 3: New Zealand Dollar against Major Trading Partners

The dollar peak at 76.9 on the Trade Weighted Index (TWI) on 24 July and then did a u-turn to hit a three month low of 65.6 on 10 September. It finished the quarter at 71.0, 5.1% lower than 30 June.

Interest rates continue to be the biggest influence on currencies and the New Zealand dollar has been strong over the past twelve months, mainly because the Reserve Bank has raised its official rate from 7.25% at the end of 2006 to 8.25% at present.

Table 4: Official Central Bank Interest Rates

Most economic forecasting groups expect the New Zealand to remain steady or to ease over the remainder of 2007 and in 2008. However with the New Zealand economy continuing to perform better than expected, and the Reserve Bank concerned about the inflation outlook, the prospect of further interest rate increases cannot be discounted. If this occurs the New Zealand dollar could remain at current levels for longer than anticipated.

SHARE MARKETS

World sharemarkets had a reasonably strong September quarter even though United States sub-prime markets and credit worries dominated the headlines.

Table 5: Gross Sharemarket Returns

Source: MSCI Barra

The MSCI Gross Index for developed countries declined 0.1% but the MSCI Gross Index for emerging markets rose an impressive 12.6%. The star performers were China, which rose 41.0%, Hong Kong up 23.2% and India plus 17.6%.

Australia also performed well as its resource stocks, particularly BHP Billiton and Rio Tinto, benefited from booming economic conditions in China and India.

After such strong gains there is a probability that resource sector growth may be more subdued and interest could switch to the finance sector. This would include the banks, which have experienced good profit growth over the past six months.

New Zealand investors have had a great run in Australia because of the strong sharemarket and the depreciation of the New Zealand dollar against the Australian dollar (see Table 3).

The NZX had a surprisingly good September quarter in spite of the finance company problems and a further 0.25% Reserve Bank interest rate hike on 26 July. The top three performing NZX companies during the September quarter were PGG Wrightson up 19.2%, Westpac 17.1% and AMP 13.1%. The worst performing stocks were Rubicon minus 21.2%, Hellaby minus 19.6% and New Zealand Exchange with a negative 17.1%.

FIXED INTEREST

New Zealand interest rates have been traditionally been higher than most other western countries. The gap widened between December 2000 and December 2005 creating a strong demand for New Zealand income securities and pushed up the Kiwi.

Table 5: 30 days bank bill yields – New Zealand & United States

The interest rate gap narrowed in 2006 and through the first half of the current year but has begun to widen again following four rate rises by the Reserve Bank of New Zealand and the 0.5% cut by the US Federal Reserve Board on 18 September.

The Reserve Bank will continue to take a tough stance on interest rates until the New Zealand economy shows some clear signs of slowing. When this becomes clear we will begin to raise client’s exposure to long-dated securities, particularly top rated corporate bonds that are backed by strong balance sheets and good cash flow.

OUTLOOK

Global growth is beginning to slow due to credit problems and higher interest rates but the strength of the Chinese and Indian economies should ensure positive world growth through to at least the end of 2008.

The New Zealand economy has remained remarkably resilient but the four interest rate rises this year are beginning to have an impact on consumer spending. The Reserve Bank could raise interest rates a further 0.25% if economic growth doesn’t slow.

We expect the domestic economy and NZX to be relatively subdued in the months ahead but the prospects for the Australian economy and ASX are more encouraging.

The main issue facing investors is the NZ dollar. The dollar remains remarkably resilient and should continue to trade at the upper end of forecasts as long as the Reserve Bank continues to be concerned about the inflation outlook. In this environment New Zealand and Australian assets should continue to offer the best returns.