Returns should remain solid in 2005

For 2005 we see four main themes:

Firstly, global growth is likely to slow but not return to recession. Leading indicators of global growth point to some moderation, driven by the lagged effect of high oil prices in 2004 along with the modest rise in US interest rates. While some see this as the start of the next recession it seems too early for this. Strong corporate balance sheets and cash flows point to strong business investment, there has been no involuntary surge in stockpiles and there hasn’t been enough monetary tightening to bring on recession. More likely, the coming moderation in growth is just a mid-cycle correction, much as occurred in 1985 and 1995 (in the midst of ongoing economic recoveries).

Secondly, commodity prices are likely to remain high, but expect momentum to slow. While the big cyclical rise in industrial commodity prices is likely over for now, the continuation of strong growth in China, reasonable activity levels in the industrialised world and constrained supply should mean commodity prices remain solid. Oil prices are likely to remain off their highs but our analysis suggests they should average around US$35-$40/barrel.

Thirdly, relatively benign interest rates. Further rises in interest rates are likely in the US, but a moderation in economic growth is likely to keep a lid on inflation and ensure rates stay relatively low. Interest rates in Japan will likely go nowhere and may even fall in Europe. Domestically, economic activity in New Zealand will moderate, but should remain reasonable by historical standards. The expected slowdown in housing investment should detract from growth, but this is likely to be offset by ongoing business investment, reasonable consumer spending, and a gradual upswing in exports. Unemployment is therefore likely to remain near its current level (3.8%) over 2005, which may put some upward pressure on wages.

The Reserve Bank of New Zealand (RBNZ) should keep the official cash rate (OCR) steady for most of 2005. The combination of the current 6.5% OCR (an increase of 1.5% over 2004), the high level of the currency, and the expected moderation in economic activity should be enough to keep inflation within the 2 to 3% medium-term range going forward.

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