Australia and New Zealand, long-time “ugly sisters” with global investors in the late 1990s, have come back into vogue in recent years as economic growth has held up, interest rates have increased, and the Australian (AUD) and New Zealand (NZD) dollars have both climbed sharply from their lows in 2001.

Both the AUD and NZD moved weaker again during the first half of 2004, but further substantial depreciation of the Australian dollar is not expected over the next 12 months, and the Kiwi dollar shouldn’t become substantially weaker either.

The Australian economy started 2004 at a much slower pace than in 2003, with growth slowing to just 0.8% per annum in the first quarter. One reason was weak exports, which were damaged by the rise in the AUD in recent years, a rise that has left the trade balance in the red for much of that period. But look more closely and the key factor that has sustained Australia’s economy – private consumption spending – was still up strongly at around 4% a year.

Still, the extent to which Australia’s economic growth and strong consumer spending has been leveraged on rising consumer debt and a housing-market boom (prices in recent years have been climbing 20% a year) is a key concern for the Reserve Bank of Australia, or RBA.

Consumers will most likely continue to underpin domestic demand this year, but there are some early signs that the housing market is starting to cool, which should also take some impetus from consumer spending and prevent inflation from taking off.

Neighbourly ties
The New Zealand and Australian economies are closely linked, so it should be no surprise that New Zealand’s growth has also been consumer-driven. But its growth has been further bolstered by strong immigration in recent years, which has in turn boosted housing investment. GDP expanded at an astounding rate of 9.5% a year in the first three months of 2004, driven by consumer spending and housing investment, so the RBNZ (Reserve Bank of New Zealand) will share the RBA’s concerns about the need to contain a consumer-debt boom.

What could go wrong?
As a large commodity exporter, Australia will be hoping that China can avoid a hard landing, since rapid Chinese growth has spurred demand for commodity exports and lifted world commodity prices. A sharp slowdown in China would hit not only export volumes to Asia and elsewhere, but global commodity prices too.

Something else to consider, meanwhile, is a potential collapse in either country’s housing market. The risk is relatively low because the most likely triggers (a substantial increase in interest rates or a sharp rise in unemployment) probably won’t happen. But if house prices were to drop substantially, interest rates in both Australia and New Zealand would eventually fall, sending their currencies sharply weaker as well.

THIS ARTICLE IS REPRODUCED COURTESY OF SMART INVESTOR MAGAZINE