Cost of living indexes continue to show life is getting tougher for those with low incomes, as the Commerce Commission shines a harsh light on supermarkets. All eyes are turning to the labour market data release next week, with jobs filled data this week confirming that employment grew strongly over Q2.
For the first time Statistics NZ have published a quarterly data series for the income measure of GDP. These data show how the wage subsidy, as expensive as it was, supported households through lockdown. Household net disposable income dropped just 0.1% q/q in 2020 Q2, despite a 10.7% q/q fall in overall income GDP during the quarter. We also updated our inflation forecasts this week in the wake of Q2’s 3.3% y/y rise in consumer prices. The broad-based momentum in the inflation numbers shows that strong CPI prints have only just started, and we’re expecting that inflation will peak at 4.2% y/y in Q3 2021. We still expect inflation to slow over the next few years, as supply disruptions and other temporary factors ease, and the RBNZ raises the OCR (starting in August).
The monetary policy cycle has reached a turning point, with the RBNZ announcing an end to the LSAP, headline inflation at 3.3% y/y, and core inflation measures hitting (and some exceeding) the top of the RBNZ’s 1-3% target range. OCR hikes are needed to cool down an overheated economy. We expect that starting with the August 2021 MPS, the OCR will gradually be lifted from the current low of 0.25%, to a peak of 1.75% at the end of 2022.
This week we brought forward our expectation for interest rate hikes. We now expect the OCR to be increased to 0.50% in the November 2021 meeting, with further hikes at each MPS until we reach a terminal OCR of 1.75% in early 2023. The QSBO reinforced what we’ve seen in our monthly Business Outlook – the economy is running red hot. Looking ahead to the Monetary Policy Review we expect a significant change in tone in the RBNZ’s Record of Meeting, acknowledging the strength in the recovery, and the intense capacity pressures building across the economy. Timely indicators from our capacity pressure suite show that pressures are building in line with what we predicted in our Quarterly Economic Outlook. All up, it’s time for the RBNZ to start removing stimulus.
Data flow continues to point to an economy that’s in a very strong cyclical position. The economic expansion appears to be well into the inflationary zone, as labour shortages, shipping delays, and other COVID-related disruptions continue to bite. As we explored in an Insight published yesterday, these disruptions are unlikely to fade anytime soon. The housing market is also still in the vice of strong demand and weak supply. Data released by Realestate.co.nz this week showed available listings continuing to grind downwards in June. That caps off a first half of 2021 where listings were well below levels seen even during the depths of lockdown in 2020. This week we published an upgrade to our labour market forecast. This reflects strong recent data, including the large 1.6% q/q rise in Q1 GDP, record-high job vacancies, strong increases in monthly filled jobs, and the near-constant flow of news articles highlighting the struggles Kiwi businesses are facing trying to find enough workers to be able to operate. If unemployment falls to 4.5% in Q2, as we expect, that would imply historic levels of labour market tightness, given super strong job vacancies.
The knife-edge Wellington COVID-19 situation is a reminder of our vulnerabilities until herd immunity is reached. For now though, the economy is running hot, as rampant demand meets constrained supply. The balance of potential policy regrets has firmly tilted, with the risk being we’ll see a higher OCR before the year is out. Our current forecast is hikes from February 2021. This implies an earlier trough in house prices, but this is offset by the economic recovery looking even more advanced than expected, with growth broad-based.
What happened this week? The Q1 GDP figure blew every market forecast out of the water. Our expectation (shared by the market) was for a 0.5% q/q rise, while the RBNZ expected a 0.6% fall. On the day GDP rose 1.6% q/q, with GDP now comfortably above pre-COVID levels (although still below a counterfactual where COVID never happened). The rise in GDP confirms that New Zealand has seen a spectacular economic recovery, and while there is residual weakness in industries exposed to international tourism, this is being swamped by domestic momentum. As a result, we have changed our OCR call. We now expect the first OCR hike to take place at the February 2022 MPS, followed by hikes in the May and November 2022 and May 2023 meetings. These four hikes would bring the OCR up to 1.25% in mid-2023.
What happened this week? The preliminary read of the June ANZ Business Outlook showed further evidence that New Zealand’s economic recovery is running into capacity constraints – ie we’re trying to grow faster than available resources and COVID disruptions will allow. This is feeding into higher prices and costs for firms, and we expect strong inflation prints over 2021 (peaking at 3.0% y/y in Q3). What are we watching? Next Thursday, GDP data for Q1 2021 are released by Stats NZ – see our Preview. We think that production GDP increased by 0.5% q/q, after a 1.0% fall in Q4.
Building work put in place (WPIP) for Q1 was released today. It lifted 3.7% (following a 0.5% contraction in Q4). This is normally a pretty reliable indicator for construction GDP. However, that wasn’t the case with the Q4 GDP release, where the 8.7% q/q fall in construction activity was much weaker than WPIP was suggesting. This week we released our Quarterly Economic Outlook. The New Zealand economy is well on the way to recovery. While some sectors are still suffering, others have bounced back so rapidly that they’re now running into severe capacity constraints. As a result, we think that the New Zealand economy overall currently has a positive output gap – that is, it is trying to grow faster than available resources can sustain. A positive output gap generates inflationary pressure – and that’s why we expect that headline CPI inflation will peak at 3.0% y/y in Q3.
The RBNZ left monetary policy settings unchanged this week, with the OCR at 0.25%, and the LSAP and FLP programmes untouched. That was universally expected. The big news was the reinstatement of the OCR track. We had been hoping to see this, especially since the RBNZ’s previous forward guidance had expired. And the RBNZ well and truly delivered, publishing an OCR track very similar to ours. As expected, the RBNZ’s forecasts have been upgraded to reflect the improved economic outlook since the February MPS. The labour market is much closer to full employment than they were expecting, and like us, the RBNZ thinks that unemployment has already peaked. That said, the RBNZ is forecasting a slower decline in the unemployment rate than we are – we think that unemployment will be around 4% by the end of 2023, versus the RBNZ’s forecast of 4.3% by mid-2024. Overall there’s probably upside risk to their labour market outlook, and this tilts the risks to a slightly earlier date for the first OCR hike.
This week the big event was Budget 2021. The Budget showed that the Government is looking to balance rebuilding fiscal buffers and addressing significant issues facing New Zealand. The Treasury’s economic forecasts were revised upwards, reflecting the improved economic outlook since the Half Year update in December. This has provided the Government with more room to spend money on key projects, whilst also staying on track to stabilise debt levels. See our Review for more details. The May Monetary Policy Statement will be released on Wednesday next week (May 26). The RBNZ is unlikely to shift from their cautious stance just yet – they remain data driven, and while we have seen encouraging signs of economic recovery, the RBNZ will want to see a few more strong data prints to be sure the economy is on track to meet their inflation and employment objectives. That said, we think conditions will continue to improve, and enough so that the RBNZ will feel comfortable starting to raise interest rates from August 2022. Encouragingly, indicators from our ANZ Business Outlook, the PSI and PMI are all pointing to economic momentum building over mid-2021.
What happened this week? Yesterday’s April house price data was the first chance to see the impacts on the red-hot housing market of the Government’s housing policy changes. As it happened, house prices rose 1.7% m/m, down from 2.8% previously (ANZ seasonal adjustment). And the number of houses sold dropped 12.8% m/m. Overall, that points to some softening in housing activity, but prices (which lag sales) have a bit more momentum than we had pencilled in. That doesn’t mean that the impact of the policy announcements is smaller than we had expected. A single data point is just the opening bid. There’s a lot going on, and we’ll need to keep our finger on the housing pulse for a while yet. But we have tweaked our house price forecast to take into account the stronger starting point (figure 1). The fundamentals of the housing market continue to suggest a moderation in house price growth from here: affordability constraints, mortgage rates that are more likely to go up than fall further, loan-to-value ratio restrictions back and bigger than ever, building consents at historical highs, and population growth that’s severely curtailed by the border closure.
What happened this week? The Household Labour Force Survey lived up to its reputation for delivering surprises, with the unemployment rate falling from 4.9% in Q4 2020 to 4.7% in Q1 2021. The details of the data were very robust, and a stronger-than-expected 0.6% q/q rise in employment saw the unemployment rate fall, despite a rise in participation to 70.4% (70.2% previously). Consequently, we’ve upgraded our labour market outlook. There was a lot of genuine strength in the release, and it looks like jobs growth will just about be able to keep pace with higher labour force participation over 2021. Consequently, we expect that the unemployment rate will hold steady at around 4.7% over the rest of 2021 (figure 2). This reflects our expectation that further strong employment gains will be hard won while the border remains closed, due to matching issues, and employment growth is likely to drop to low (but positive) levels over H2. Combined with a slight uptick in the participation rate to 70.5% in Q2 (vs 70.4% in Q1), this sees the unemployment rate drift sideways for the next 12 months.
Q1 labour market statistics will be front and centre next week. We expect to see a small lift in the unemployment rate to 5.1%, but the participation rate is a bit of a wild card and the possible range of outcomes is wide (table 1). The details of these data will be important. A tick down in the unemployment rate alongside weak participation would suggest there could still be some way to go towards recovery, while a higher unemployment rate coupled with markedly higher participation and solid employment growth would suggest a more advanced recovery. Looking forward, the RBNZ will be assessing a range of measures, such as the underutilisation rate. They’ll require broad-based improvement across the suite of indicators they monitor before concluding employment is at or above its maximum sustainable level. A positive surprise in the Q1 data is extremely unlikely to go that far.
This week Stats NZ released CPI inflation data for Q1. Consumer prices rose 0.8% q/q (1.5% y/y) vs our expectation of a 0.7% q/q rise (figure 1). The outturn was more or less as expected, with temporary drivers pushing the headline number higher. This data underscores the need for patience, as the RBNZ has been saying for some time now. The details show that temporary factors are supporting prices, and core inflation measures may not be the most reliable guide right now. And, as the RBNZ emphasised in the recent Monetary Policy Review, they want to see evidence that CPI inflation will be ‘sustained’ at 2%, and the Monetary Policy Committee is anticipating a ‘prolonged period of time’ before conditions are in place for this. We’ve updated our inflation forecasts to account for two factors. Firstly, tradables inflation was stronger than expected in Q1 (a technical change). Secondly, continued labour market pressure has led us to revise up our near-term non-tradables and wage inflation forecasts. As we noted in a recent Insight, labour shortages remain acute in New Zealand, despite the unemployment rate still being above pre-pandemic levels. And, demand for labour has only increased, with job-ads now at record highs less than a year after a recession.
What happened this week? The RBNZ met this week and, as expected, made no changes to policy settings. The RBNZ reiterated its wait and see approach, including on the likely effects of housing policy and travel bubble announcements.
What are we watching? CPI inflation for Q1 is released on Wednesday. As we outlined in our Preview, we think consumer prices rose 0.7% q/q (1.3% y/y). That’s off a 0.5% q/q rise in Q4. The bottom line is we don’t expect the data to be a game changer for the RBNZ. Of particular note was MBIE job vacancies data for March – this data can be volatile, but even when we smooth it, we’re looking at a record high for the series.
How has the view changed? On Tuesday the Government announced the opening of a travel bubble between New Zealand and Australia from 19 April. This is fantastic news for families and friends who have been kept apart for a year, Kiwis desperate to get out and about, and tourism firms who have battled through a summer without international tourists. Wednesday next week will be the RBNZ’s first opportunity to comment on the state of the world since the February MPS. As we outlined in our MPR Preview yesterday we’re expecting that the Monetary Policy Committee will reiterate their “wait and see” approach.
How has the view changed? This week we've been keeping an eye on indicators of activity in the construction sector. While timely indicators for this sector can be pretty noisy, we're seeing an emerging risk that residential building has been more constrained by supply and capacity pressures than we previously thought. The construction sector has been the star performer of New Zealand's post-lockdown economy, driving economic momentum forwards. But with the sector running into serious capacity headwinds, there's a question around whether this momentum can be sustained. To start with, our recent Business Outlook showed that pricing intentions and cost expectations in the construction sector continued to grind higher in March, whilst confidence, activity, employment, investment, and profit all declined - clear signs of hitting some kind of constraints. It's not unusual for construction sector firms to get into trouble during very busy times due to stretching themselves too thin, but the supply shortages we're seeing - and in particular, the associated project delays - could cause considerable cash-flow pain. Once capacity constraints start to grip the sector, rising costs can seriously impact the bottom line, especially for larger multi-unit developments.
How has the view changed? Of the Government's suite of housing policy announcements this week, the removal of interest deductibility on investment property is the one that surprised us - it's bold. We doubt we'll see a sudden flood of sales as investors run for the hills en masse. The peak impact on property investors likely won't be until year 5, because the policy will be phased in over four years. But, it's true that buying a new investment property today is less appealing and riskier than it was last week. And the highly leveraged investor has been top bidder at a lot of auctions lately. All up, we expect this to take the wind out of the housing market's sails (and sales) faster than we previously thought, but we think there's enough competition out there to prevent a complete landslide. For annual house price inflation, we now expect a peak of just under 25% mid-year (about 2%pts lower than previously) and a faster decline from there.
How has the view changed? This week Stats NZ released GDP data for Q4. It was always a toss-up whether we would see the economy expand or contract. On the day, GDP declined 1.0% q/q against our expectation of a 0.5% rise. That's definitely a sizeable negative surprise, but it's not enough to change our overall view of the economic outlook. The real challenge is trying to work out how much of a signal to take from this data. The data is still pretty noisy under the hood, and it looks like some of the drop in Q4 came from industries experiencing a technical retracement from their record rises in Q3. But it's also true that the headline numbers are probably understating the degree to which the economy was hurting over 2020. When we compare what actually happened in 2020 with a counter-factual scenario in which COVID never happened (figure 1), we estimate that the economy is around 5% smaller than it would have been.
This week REINZ data for February showed that the housing market is still running hot. House prices surged ahead 3.7% m/m, with annual house price inflation now sitting at 19.4% y/y (3mma). Notably, average days to sell declined to 26 – a record low for this data, which goes back to 1992. This indicates that housing inventories are extremely stretched by strong demand. The robust outturn presents upside risks to our house price forecast and the broader economic outlook. We expect that unaffordability, high debt levels, the re-imposition of LVRs, credit constraints, and high levels of residential construction activity will see house price inflation cool down over 2021 – but the timing and extent of this is uncertain. In the meantime, the strong domestic housing market continues to support activity in the wider economy.
5 March 2021:Dairy strong, capacity biting in construction (PDF 404kB)
How has the view changed? The new COVID-19 outbreak was on everyone's minds this week, with Auckland back into Level 3 and the rest of the country in Level 2. While as of yesterday there had been no new community cases in four days, the recent lockdowns remind us that New Zealand's stellar economic recovery is extremely fragile until herd immunity is achieved and the risk of returning to lockdown fades. While lockdown dampened the mood domestically, our global commodity prices defied gravity. The ANZ World Commodity Price Index rose 3.3% m/m in February - and even more gains were seen this week. In the GlobalDairyTrade auction, whole milk powder prices rose a whopping 21%, supporting a 15% rise in the overall GDT price index. Consequently, we revised up our farmgate milk price forecast for the 2020-21 season to $7.70/kg MS.
How has the view changed? The Minister of Finance announced yesterday that housing would be added to the RBNZ’s Financial Stability Remit, stating that, ‘the Bank will have to take into account the Government’s objective to support more sustainable house prices, including by dampening investor demand for existing housing stock to help improve affordability for first-home buyers.’ The Minister has asked the RBNZ for advice on debt-to-income limits and interest only loans, which could lead to the RBNZ’s macro-prudential powers being beefed up. But these appear likely to apply to investors only. When setting monetary policy, the RBNZ will also have to “assess” the impact on housing sustainability. That means the interaction between monetary policy settings and housing is likely to become a more prominent part of RBNZ communications, but it won’t have a meaningful impact on policy settings.
How has the view changed? Hold the line. That’s been the theme within our internal discussions as we’ve worked to digest the data flow and separate noise from signal. Higher house prices remain a massive driver of domestic momentum at present, but sales have shown some signs of returning to more normal levels, albeit from a pretty nutty place last year. That’s in line with our assumption that house price inflation will slow this year to something around average, as policymakers try to engineer a soft landing and as affordability and credit constraints bite. A weak PSI number this week confirmed all is not well in services industries, and soft migration data once again reminded us that we cannot rely on population-led growth to support GDP. But another strong GlobalDairyTrade result offered some relief and added further justification for the elevated NZD. Then there’s the renewed lockdown measures. A short, sharp lockdown like we’ve seen shouldn’t cause too much of a loss in broader activity, but some (namely Auckland hospitality) will certainly feel it more than others. And another round remains an ever-present risk. None of the new news above challenges our broader macro view, but it all goes to show that this crisis is pushing and pulling the economy in many directions – and it’s not over yet.
How has the view changed? Although data volatility is still expected, the dust has settled sufficiently to see how resource pressures are faring and, as such, we have updated our ANZ capacity suite. Consistent with our view that more stimulus is not required, our estimates of the degree of resource pressures in the economy suggest that in aggregate the economy is operating with only a little spare capacity – though clearly experiences across the economy are very varied. This picture is far better than the RBNZ dared hope three months ago, reflecting a much greater surge in demand out of lockdown than anticipated, while the economy continues to grapple with supply constraints. We expect the RBNZ to remain cautious, looking for assurance that its targets can be achieved sustainably, especially given closed-border headwinds and downside risks to the outlook. But clearly, the economy is much closer to full employment than the RBNZ ever envisaged, and that does raise the spectre of policy normalisation in time. We think that the RBNZ will want all its ducks in a row before embarking on this process, with employment, inflation and inflation expectations sustainably near target, and downside risks having abated. That will take time. At this stage, we see tapering of LSAP purchases as the first part of this process, potentially in the second half of 2022 based on current forecasts. See our ANZ Insight – the path to normal for more details.
We no longer expect the RBNZ to cut the OCR again this cycle, with the economy more resilient than previously believed. This view reflects a range of factors, but especially a better starting point for the labour market. Recent developments take further monetary stimulus off the table, provided downside risks do not materialise, with the outlook for inflation and the labour market looking even more assured (see Economic Forecasts). The RBNZ will want a high degree of certainty about sustainably reaching its goals, which speaks to policy being on hold for a long while (including an extension to the timeframe of the LSAP programme – which implies a slower pace of asset purchases, but importantly, also gives the RBNZ optionality). But for now, the RBNZ has done enough.
How has the view changed? Recently we updated our forecasts to reflect stronger economic momentum into 2021, which means a better outlook for the labour market too. Better prospects for inflation and the labour market tilt risks away from further monetary policy easing. But we haven’t seen the peak in unemployment yet, and continued caution is warranted. Headwinds to the economic outlook, especially related to the closed border, are expected to weigh on employment this year, with the unemployment rate expected to peak near 6% in mid-2021. We expect the RBNZ will extend the LSAP guidance in February, affirming forward guidance that monetary conditions will remain expansionary for some time. Although the data is yet to show it, we are assuming these headwinds will become more evident in time, motivating the RBNZ to cut the OCR once more ‘for luck’ to 0.1% in May. However, this may not be deemed necessary if the strong data run continues.
Improvement in the labour market is expected to be gradual until herd immunity is reached and the border opens, with faster declines in the unemployment rate possible once economic activity normalises and the recovery accelerates and evens out. Down the track, once the RBNZ’s targets are in sight, policy normalisation will be on the cards. There is significant uncertainty when looking that far into the future, but tightening in monetary conditions may be able to start by mid-2023 based on our current forecasts, and upside risks could see this happen sooner.
How has the view changed? Today’s Q4 CPI data were stronger than expected, with a solid 0.5% q/q lift. We’ve updated our forecasts for the starting point. Volatility in annual inflation is expected in coming quarters, due to recent noise. As we expected, scarcity of goods resulted in pockets of price pressure in Q4 on the back of rising shipping costs and supply disruption – in fact, this impact was even greater than we expected. But these impacts are expected to be transitory and the RBNZ will look through them, plus they aren’t great for growth. Over the medium term, our forecast for a gradual lift in underlying inflation remains the same – with a strong NZD, fragile global backdrop and domestic challenges (like the closed border) providing headwinds. Encouragingly, though, core inflation measures have generally lifted. Although these may ease from here, this is good news for the RBNZ. A stronger underlying pulse is supportive of inflation expectations and a better starting point makes returning to target just that bit easier. We expect the RBNZ will remain cautious about downside risks, but they may not need to cut the OCR further if momentum in the economy can be maintained. Indeed, the housing market could tip the balance there. We’ve recently added a little more oomph into our outlook for house prices, but a picture that is even stronger than we expect could tip the balance away from a further OCR cut in May.
How has the view changed? We now expect only one more OCR cut in May to 0.1%. That means a negative OCR is now off the table unless downside risks materialise. Underpinning our updated call is a stronger starting point and outlook for the economy (see Economic Forecasts). The economy bounced strongly (14% q/q) in Q3, and we now expect a little more momentum on the back of a stronger housing market (see our ANZ Property Focus out next week), business resilience and higher export prices, including a better milk payout. This means that there is less spare capacity in the economy than previously feared, meaning fewer job losses. We now expect the unemployment rate to peak at a lower level (6% versus 7%). The medium term outlook for inflation is also looking more assured on stronger GDP and improving inflation expectations. Still, the starting point is low and improvement will be gradual. In this environment, it will take some time for the RBNZ to be confident that it will meet its targets, justifying a little more stimulus, especially as the economy experiences a wobble into 2021. Strategically this is consistent with the RBNZ’s ‘least regrets’ approach. That said, should the economy maintain momentum, it would be easy to make a case for no further cuts at all.
How has the view changed? Economic activity bounced back sharply in Q3, adding to the recent broader picture of resilience in the economy, supported by fiscal and monetary stimulus. It has been an unprecedented – and very uneven – downturn and subsequent rebound. Some industries are likely to see a pull-back in activity as we end the year. But overall, the recent data flow has been more positive, supporting a stronger fiscal outlook and suggesting further monetary stimulus may not be needed. A number of key themes will set the tone for the year ahead (See What are we watching?), with some longer-term challenges increasingly in the public eye. Worsening housing affordability, in particular, needs urgent attention. Bold action to achieve an orderly stabilisation or decline in house prices is fundamentally necessary.
How has the view changed? It now looks like GDP has seen even more volatility than previously expected, though overall the level of activity has been a touch stronger than previously assumed. We expect that GDP bounced 14% q/q in Q3 – a more vigorous recoil than previously forecast. However, the data does appear to be affected by significant volatility, with a retracement in GDP now expected though the end of the year. That means we are now forecasting a technical double-dip recession. It’s best to think about that as a matter of timing rather than substance, though, with the story very little changed overall, especially over the medium term. For policy settings, a slightly better Q3 bounce is really neither here nor there, though relative to earlier in the year, the outlook has undoubtedly improved. That will be reflected in a better set of economic forecasts at the Half-Year Economic and Fiscal Update next week, along with a small downgrade to the bond programme. Eventually, this is expected to see the RBNZ adjust the LSAP, given there will be fewer bonds to buy, potentially with an extension of the purchase timeframe at the February MPS.
How has the view changed? We have upgraded our NZD/USD forecast and now expect the Kiwi to drift higher towards 0.74 over 2021. That’s largely a story of USD weakness, fuelled by improving global growth and easy monetary conditions in an environment where central banks will not want to be too hasty with policy normalisation. We see the NZD and AUD both higher, with the AUD getting a bit more oomph given the already high level of the NZD, seeing the NZD/AUD drift lower. In trade-weighted terms, the NZD is expected to move about 1% higher by end 2021 (see Market Forecasts table). The NZD will remain a headwind to inflation and a headache to exporting and import competing firms that the RBNZ may need to work against if the economic recovery does not maintain sufficient momentum. It’s difficult to swim against the global FX tide, but stemming further gains may be necessary, and monetary policy can help with that. The RBNZ estimates that the NZD would be another 7% higher were it not for stimulus seen to date.
How has the view changed? Our expectations for the OCR outlook haven’t changed, but the odds are increasing that a negative OCR won’t be required – and that’s a great thing. Much will depend on developments though. We are not ready to take a negative OCR off the table just yet – and we don’t think the RBNZ is either. There are genuine reasons to be optimistic, given the success of our health response, vaccine news, resilience of business and consumer confidence and the effectiveness of policy. But the loss of international visitors through summer will make a meaningful dent at a time when temporary fiscal support has ended, meaning economic momentum may wane. That said, housing could tip the balance to less monetary support being needed if momentum continues (check out our latest ANZ Property Focus), and the policy debate around housing affordability is heating up. For markets, the recent positive vibe now appears to be “in the price” – markets have repriced OCR expectations significantly. However, it may take time to get clarity on developments, which could leave the market in wait-and-see mode for a while. Meanwhile, the NZD has continued to march higher, altogether leading to a tightening in financial conditions that the RBNZ may need to offset down the track.
After a period of very effective damage control from the COVID-19 crisis, the time for a more nuanced policy response appears to be upon us. Direct fiscal support from the likes of the wage subsidy have now effectively worn off. Assuming no further community outbreaks of COVID-19 in New Zealand, the Government must now turn to the challenging task of supporting the recovery and evening out the unequal impacts of this crisis across industries and society more generally. The outlook for monetary policy has now become a more delicate balance too. Unfortunately, we probably won’t get much clarity on the path ahead until the New Year. This could leave markets struggling to find direction.
We are now expecting a more gradual path lower for the OCR, and whether a negative OCR will be deployed at all is much more of a line-ball call. At the November MPS the RBNZ provided more stimulus via the Funding for Lending Programme (FLP), but acknowledged more recent positive domestic news. The RBNZ's forecast for the unconstrained OCR - the level of stimulus needed to achieve the RBNZ's objectives, achieved through the Bank's suite of alternative policy tools - is now significantly higher. From a current level of -0.65% to -0.8%, it now reaches a low of -1.5% versus -2.4% previously - an upward revision of almost 100bps. The market took this as a strong signal that a negative OCR would no longer be required (see Markets Overview for more), but this move appears overdone to us. It is entirely possible that a negative OCR will not be needed, but on balance, the outlook is still consistent with a bit more stimulus in time, especially since the FLP is not expected to go the whole hog (see What are we watching?).
The unemployment rate for Q3 was as expected, at 5.3%. This is a much better picture than many had feared as the crisis was unfolding and better than the RBNZ forecast at the August MPS. Nonetheless, job losses are rising (especially amongst women), while an increasing number of workers would like to work more but can’t. Slack in the labour market is expected to worsen as the economy enters the challenging period ahead. Certain pockets remain vulnerable, but the impact is also expected to broaden in time. We remain of the view that the unemployment rate will peak at 7.5% late next year. This week’s data adds to a recent string of more positive domestic news, including the buoyant housing market, where a speculative dynamic appears to be emerging. Next week the RBNZ is expected to announce a Funding for Lending Programme (FLP) to provide more stimulus. But the MPS will need to acknowledge that conditions are better than they feared. Over time the outlook for policy will become more nuanced, with the case for more support becoming less obvious. Recent developments reduce the odds that we’ll see a negative OCR, though at this stage on balance we still think it will occur.
The outlook remains highly uncertain, and risks abound. But, as we outlined in our Quarterly Economic Outlook for October, we think there are a number of key themes that look set to shape the outlook ahead. The difficulty for policymakers is that there are a number of ways this could play out, and by the time we know what state the world is in, the opportunity to respond with timely policy will be behind us. On the fiscal side, policy must also balance the need to support the recovery, with the longer-term financial implications. For monetary policy, the case for more stimulus remains clear for now, with a Funding for Lending Programme (FLP) expected in November, followed by a negative OCR in April. But stimulus to infinity doesn't make sense, and the time is approaching when the RBNZ will need to weigh up its decisions and the optimal combination of tools more carefully. Look out for our November MPS Preview next week for more details. Labour market data are also out next week, with a wide range of outcomes possible. With the wage subsidy still supporting businesses through Q3, the impact of this crisis has been muted, and we expect to see that in the data. That said, we remain squarely focused on the medium-term outlook, with further deterioration expected as policy supports wane and the recovery stagnates.
How has the view changed? The NZ General Election results landed pretty close to where the polls suggested they would. Labour’s clear majority has kept a lid on uncertainty that has in the past to lingered weeks after election night as political parties negotiate to form a Government. Markets seem to have taken the results in their stride – and for good reason. From a macroeconomic perspective, overall fiscal policy settings look set to be little changed from those presented at the Pre-election Update. While there will be a slightly different mix of policies going forward (as prior coalition policy intentions are reprioritised to implement Labour’s Election Manifesto), the outlook for deficits and debt should be little changed. In fact, it’s possible that changes to the Treasury’s economic outlook in the upcoming Half-year Economic and Fiscal Update (likely to be released mid-December) have more bearing on the fiscal forecasts than discretionary fiscal policy changes do. We’ll have more to say about fiscal policy in our ANZ Quarterly Economic Outlook next week. Q3 CPI saw annual inflation decelerate further. Near-term price movements aren’t exactly in the driver’s seat right now when it comes to monetary policy settings, but the weak starting point will be of concern to the RBNZ as it could further suppress inflation expectations. And while the data is expected to remain noisy for a little while yet, the weak global inflation pulse and waning underlying economic momentum are both pointing to softness over the medium term. The RBNZ has more work to do, and we think the next cab off the rank will be the announcement of an FLP at the November MPS. This will take pressure off the LSAP, but certainly not replace it, and provide the RBNZ more time to weigh the outlook for the OCR.
How has the view changed? We have upgraded our forecasts for GDP, the labour market and inflation on the back of a stronger housing market and improvement in business sentiment. While we still expect that the economy will face challenges in coming quarters, a buoyant housing market and less pessimistic firms will have a cushioning effect on employment and spending, partially offsetting some of the headwinds ahead. We now see GDP bouncing back a little bit more strongly through the second half of this year. The unemployment rate is expected to rise a bit more slowly than previously assumed, with activity a little stronger, the wage subsidy delaying job losses, and effects of the closed border not evident just yet. A serious test for the economy lies ahead though, with a softer growth pulse expected to be evident from the first half of 2021 onwards. The unemployment rate is expected to rise to 7½% by the end of 2021. We continue to expect a deceleration in inflation as we enter next year, though in the short term inflation is expected to remain bumpy. For the RBNZ, the outlook is looking a little more positive than was included in their August MPS forecasts, but downside risks remain. We expect that the RBNZ will drop the OCR 50bps in April next year, but risks around this outlook are looking more balanced, rather than firmly to the downside.
How has the view changed? The RBNZ has confirmed that more details about a possible Funding for Lending Programme (FLP) will be released with the November MPS. These details will determine take-up of the funds by banks and ultimately the scheme’s effectiveness. Another key determinant of the scheme’s impact will be credit demand, which may be constrained as the impact of the current downturn becomes clearer in coming months. Prior to the November MPS, CPI data will be released for Q3 (October 23). We see upside risk forming to our current pick of 0.8% q/q. See ‘What are we watching?’ for more details. Overall, we expect to see a solid bounce, but that follows a super-weak Q2 outturn, and the RBNZ will remain focused on the subdued medium-term outlook and low inflation expectations. In comments to the press this week, the RBNZ reinforced its dovish, least-regrets approach, which has not wavered in the face of a resilient housing market and an encouraging improvement in business sentiment and activity indicators). We remain of the view that while an FLP would be stimulatory, the RBNZ will still deem it necessary to take the OCR negative in April next year – particularly with the economy expected to enter a more challenging period ahead.
How has the view changed? Through the winter months housing demand has been strong, while new listings have been low, making the market very tight (see our ANZ Property Focus for more details). This week, data showed that the usual spring flurry of listings has begun, which may see tightness start to dissipate, though no catch up is evident. Heat through winter has been on the back of fast-acting supports. But dampening factors – like rising unemployment and weaker net migration – are expected to weigh more gradually, and a summer chill could emerge in time, though the outlook remains highly uncertain. We have long said that the test for the economy is coming as we enter the summer months, and that time is fast approaching, with fiscal supports now starting to dissipate. The labour market has been resilient on account of the wage subsidy, but we expect that job losses will rise in time – it is simply a question of how much. Our ANZ Consumer Confidence Survey out this morning showed that households are worried – and that’s understandable, with firms intending to reduce headcount. Our ANZ Business Outlook shows that firms intend to shed workers overall, though less so than in previous months, with particular weakness in retail and services industries.
How has the view changed? The Monetary Policy Review this week yielded few surprises: the RBNZ left policy unchanged, reiterated their OCR forward guidance, and will continue tactical purchases under the Large-Scale Asset Purchase (LSAP) programme. They reiterated that they favour a negative OCR and Funding for Lending Programme (FLP) combo for providing more stimulus if required. But they indicated that they may choose to deploy an FLP by year end, and could do so quite separately from the decision to implement a lower or negative OCR. The idea of an FLP is to reduce bank funding costs and encourage lending (for more, check out our recent FAQ). To us, this speaks to the RBNZ maintaining optionality. While the RBNZ was dovish, a negative OCR is not guaranteed, and the RBNZ will be influenced by developments as they unfold, with a front-loaded, least regrets approach. To be clear, we do think that the OCR will go negative, with a cut of 50bps in April next year true to the RBNZ's forward guidance. In our view, risks are skewed towards more cuts eventually, but a successful FLP is more likely to push out the next cut than bring it forward. But there's water to flow under the bridge yet, and the November MPS marks an important milestone. At that time, we think the RBNZ may signal a negative OCR is likely with a downward slope in the OCR projection conditional on their baseline view and strategic response. Implementation of an FLP at that time is also possible.
How has the view changed? While it was an action-packed week, it threw up little in the way of surprises. The sharp drop we saw in Q2 GDP was in line with our expectations (‑12% q/q) but will prove to be volatile and subject to revisions. In any case, it’s the medium-term story that matters and we remain circumspect about that, especially with the closed border expected to deliver a blow to tourism as we enter the usually busy summer months. This is a recession like no other and there is a long road ahead. Likewise, Treasury’s economic and fiscal projections ahead of the election were as expected and in line with our own view of the outlook: not flash. Of interest to markets was a reduction in projected bond issuance. Less supply means a higher price, so that saw markets get a wriggle on, pushing yields a little lower. Still, long-end bond yields remain above recent lows and we see scope for them to go even lower in time.
How has the view changed? We have updated our expectations for Q2 GDP out next week and now expect a fall of -12% q/q, rather than -17.5%. That's a big change, but it largely reflects a paucity of reliable data, rather than a change in our fundamental view. With the data noisy, policymakers are expected to largely look through it. Our medium-term view remains broadly unchanged, with the lesser forecast fall in Q2 meaning the rebound in Q3 will be smaller too. For Q3, we are now pencilling in a bounce of 8.5%, rather than 16%. This includes an expectation that renewed restrictions will weigh on activity. Further out, we continue to believe that the economy will undergo a serious test as we enter the summer months, with the impacts of a closed border becoming more evident and the economy coming off fiscal life support. The housing market remains resilient - and that's a good thing. House price falls often happen in downturns and their implications can be severe. However, we still expect to see a wobble into next year.
How has the view changed? RBNZ Governor Orr’s speech was as expected, reiterating previous messaging. However, we consider two aspects worth emphasising, as they underscore key elements of our view. The first was Orr’s reference to wanting to see interest rates lower than they are now. That reinforces our expectation that monetary conditions will keep easing; a negative OCR and Funding for Lending Scheme are expected next year but the RBNZ will not be complacent in the meantime. We think the MPC will flex its tactical approach to the LSAP in September, directing staff to ramp up purchases with an LSAP expansion in November to $120bn. The second key element was Orr reinforcing the RBNZ’s forward guidance that the OCR would be on hold at 0.25% “for at least a year”, following its commitment in March. Some have speculated that the RBNZ might drop this guidance, with this risk currently reflected in market pricing. But we see the RBNZ as very committed to its guidance and, as such, we do not expect an OCR cut until April, though the RBNZ may choose to foreshadow or commit to it sooner than that. Why not go sooner if more stimulus is needed? The RBNZ is playing the long game. If they renege on their guidance now, who’s to say they won’t do the same again? Reneging could jeopardise the RBNZ’s future ability to provide trusted guidance that shapes market pricing and inflation expectations down the track (eg to stem an increase in yields). February or April might seem neither here nor there, but in terms of credibility it is paramount.
How has the view changed? We have updated our inflation forecasts following updates to GDP and the labour market. With more QE on the way and the OCR expected to go negative next year, we now see a stronger economic recovery through 2022, supporting a better outlook for non-tradable inflation. Stronger world import prices also contribute to a better outlook for tradable inflation. Near-term data flow has also seen us revise up our inflation pick for Q3 2020 from 0.5% q/q to 0.8%, which would see annual inflation stable at 1.5%. However, there is more data to come that will shape this pick. In an absolute sense the inflation outlook is still very weak, even with more stimulus on the way. Inflation is expected to start creeping higher as recovery eventually takes hold, but slack in the economy is expected for some time and the elevated TWI will weigh. We see CPI reaching 1.4% y/y by end-2022, still well below the 1-3% target midpoint. We see risks to the inflation outlook in both directions: downside risks to the activity outlook could weigh, but if the RBNZ can generate a sharp depreciation in the TWI with further policy action, that would see a welcome stronger pick-up in inflation from here. But for now, the exchange rate remains resilient. World prices for our imports will also be important.
How has the view changed? We now expect the RBNZ to take the OCR negative next year, with a 50bp cut to -0.25% expected in April, alongside the introduction of a bank ‘funding for lending’ programme (FLP). Between now and then, the RBNZ will signal a steadfast intent to support the economy, with another increase in the LSAP expected in November, potentially to $120bn over two years. The economic outlook is simply too dire and the downside risks are too great for the RBNZ to sit back and wait. We’ve updated our GDP and labour market forecasts to incorporate recent developments. These include a stronger starting point, the negative impacts of renewed lockdown and weakening in underlying momentum, and the supportive impacts of increased fiscal and monetary stimulus. For markets, RBNZ words and actions should cap the NZD and pave the way for yields to go lower and geographic spreads to narrow. We’ve updated our Market Forecasts to reflect these changes to the outlook.
How has the view changed? Downside risks to our forecasts are manifesting with the detection of community transmission of COVID-19 on our shores. It’s too soon to say what the impact of this will be; uncertainty is immense. But data will be volatile for longer and there will be clear output losses. The RBNZ expanded the LSAP programme (QE) to $100bn, exceeding our top-of-market expectation of $90bn. They also expressed a preference for a negative OCR and funding for lending programme as the next cabs off the rank after the LSAP, with the odds of more being needed rapidly increasing. The RBNZ’s dovishness will weigh on the yield curve and NZD in coming weeks, helping to support the economy through the uncertain time ahead.
What are we watching? The key focus is the MPS next week, which should provide clarity in a number of areas. There is some uncertainty about where the RBNZ will land on QE, but the greatest room for surprise is likely to be what the RBNZ says on other unconventional monetary policy tools. We expect that the RBNZ will keep its options open, with a negative OCR and foreign asset purchases on the table, reaffirming market expectations that a negative OCR next year is a non-trivial possibility (with 25bps priced in by mid-2021), and keeping a lid on the elevated exchange rate. A move to a tactical approach to weekly purchases, while not expected, would also be helpful to get the most impact out of the current QE programme, and could shake up the bond market. The RBNZ's decision and commentary will inform our thinking about the policy outlook should downside risks materialise, and it is hard to know exactly what criteria they will settle on for deployment. We await the Statement with an open mind.
How has the view changed? Overall, we continue to see risks to our GDP forecasts as balanced – but timing matters a lot. There is a little upside risk to Q2/Q3 GDP, reflecting the recent bounce in activity. But this is being affected by volatility and timing effects, with the impact of this recession likely to be felt most acutely as we enter the summer months, when the trend is expected to become clear. Once the noise subsides, we expect that GDP will enter 2021 at 5% below pre crisis levels. This view has not changed (with GDP in the 2020 year forecast to be 8% below 2019 levels). As the full brunt of the recession becomes more obvious in Q4, a double-dip recession is a non-trivial risk. Downside risks could see additional monetary policy tools deployed eventually, including a negative OCR next year, though QE remains the main game in town. The August MPS is shaping up to be a big event, with key decisions about the current QE programme expected, and more details on how the RBNZ is thinking about other tools should they be needed in time.
The post-lockdown bounce in high-frequency indicators continues, including a strong pick-up in the PMI and PSI data. In isolation, these point to a vigorous bounce in near-term GDP, but there are some conflicting messages when the full suite of economic indicators is considered together. The housing market has also seen a bounce as lockdown has ended, due partly to low mortgage rates and temporary supports. We expect that house prices will fall 5-10%, with a sharper correction now looking more avoidable. Commodity prices remain resilient and dairy returns are in a stronger position as new-season milk starts to flow, though we expect dairy prices to ease later in the season. We have upgraded our farmgate milk price forecast for the 2020-21 season to 6.50/kg/MS. The solid near-term bounce in activity, resilient commodity prices and a better housing outlook are helping to temper some of the downside risk we see to our forecasts. We now see risks to the GDP outlook as balanced, though the bands of uncertainty remain wide.
How has the view changed? The housing market has been supported by a post-lockdown bounce, at a time that would usually be seasonally weak, adding to the potential for noise. Lower mortgage rates, wage subsidies and mortgage deferment schemes have supported prices, potentially delaying any weakening in the market as unemployment rises, and possibly muting the impact to some degree. The outlook is highly uncertain. We will have more to say in our ANZ Property Focus next week. CPI inflation was weak (-0.5% q/q), as expected. But that data was clouded by noise and measurement issues. The RBNZ will look through some of that, but the underlying pulse is no-doubt weak, with the exchange rate acting as a potent headwind and inflation expectations low. We continue to expect that CPI will fall below the RBNZ's 1-3% target range later this year, with the RBNZ still putting its foot firmly on the stimulus accelerator.
How has the view changed? The post-lockdown rebound continues, with our ANZ Business Outlook Flash seeing confidence continue to improve. Our enviable position, global liquidity and resilient commodity prices continue to put the wind up the NZD. The outlook remains uncertain; we see a range of scenarios as possible, subtracting 5-12% from GDP this year. With risks skewed to the downside, implications for policy are clear: make it count. For fiscal policy, that means a targeted and considered response. Initiatives to support investment and hiring would be welcome, like cutting red tape or labour market reform. For monetary policy, that means going hard and going early. If downside risks materialise, the RBNZ may take a kitchen-sink approach. That’s why it pays to be prepared for a negative OCR, even though we don’t think it’s probable. We will get more guidance form the RBNZ on the outlook in August. But until then, rates markets will continue to ebb and flow.
How has the view changed? Globally, recent intensification in the spread of COVID-19 in certain regions (especially the US) are concerning and threaten the fragile economic recovery. For New Zealand, a deep recession is inevitable and we will not be immune to global economic developments, even if we remain COVID-free. For central banks, supporting the recovery and managing risks mean that the path of least regrets is a front-loaded and aggressive approach. We see the RBNZ expanding QE to a $90bn limit in August, with a widening in eligible assets and other tools put on the table for if and when required. We see a case for more front-loading of weekly LSAP purchases, but these have settled into a steady pace. That leaves August as the next opportunity for the RBNZ to generate market impact, with supply developments influencing bond markets in the meantime (see Markets Outlook for more).
How has the view changed? The RBNZ was dovish, reaffirming our view that the LSAP (“QE”) will increase to $90bn in August. The RBNZ emphasised that the outlook is uncertain and bleak, and that they have no intention to muck around. Any change in the LSAP will be intended to make a meaningful difference. The RBNZ is keeping its options open and we think the RBNZ’s LSAP indemnity will be widened in August. Foreign asset purchases will be included as an addition, and we expect they will be the first cab off the rank. In the meantime, we see scope for the RBNZ to increase the pace of weekly purchases under the existing $60bn cap, especially at the long end. The introduction of a new long (2041) NZGB is hanging over the market. But even without that, upward pressure on yields has emerged that we see the RBNZ leaning against if it intends to keep monetary conditions easy. See Markets Outlook for what this might mean for markets from here.
How has the view changed? Q1 GDP out this week didn't change our view, with a 20-21% drop estimated over the first half of the year, but noise in the quarterly numbers. The emergence of new COVID-19 cases this week remind us that while New Zealand is extremely fortunate to have eliminated community transmission of the virus, we can't be complacent. Downside risks are very real. We expect that more QE will be needed from the RBNZ, but with the outlook a little brighter and more good news in the near term, we think the RBNZ will wait until August to scale up. Next week's OCR Review is likely to offer no surprises in the meantime, but a challenging outlook will be emphasised. Market sentiment has been weighed down by new virus outbreaks in China, a lack of progress in the US and new cases here. Soft GDP data underscores the need for lower and flatter yield curves, especially with the high TWI tightening financial conditions. See markets outlook for more details.
How has the view changed? The move to Alert Level 1 has occurred a bit earlier than previously expected and the tone of the data has also been a little more positive. We have upgraded our forecasts, but only slightly. The outlook is still very dire. A second wave of bad economic news is expected in time, at which point the reality of the long, painful recovery ahead will settle in. We see GDP 7-9% lower this year (previously 8-10%). With unemployment rising rapidly and inflation well away from target, the RBNZ has its work cut out and will need to stay the course with monetary policy. We continue to expect QE to be expanded to $90bn in August. Global yield curves have resumed flattening in the wake of the US Fed's dovish FOMC statement. But the Fed's tone has weighed on risk appetite and the NZD. See markets outlook for more details.
New Zealand is nailing it when it comes to getting COVID-19 on the run - touch wood. That's certainly going to be a factor supporting the economic recovery. So too - at least in the near term - will be a faster phasing through Alert levels than we have previously assumed. However, despite these positive developments the medium term outlook remains grim. We think the nature of this shock will weigh particularly heavily on the labour market - and therefore households. Some of the hardest-hit sectors are very labour intensive, and there isn't an obvious outperformer lying in wait to pick up the slack. A second wave of lay-offs is likely once the wage subsidy expires. However, fiscal policy was never going to be able to save every job. Now, policy needs to focus on the recovery. On that front, there's certainly more the Government could be doing, but there are no easy choices here. Trade-offs are significant. But without further action, risks to the employment outlook will remain skewed to the downside.
Tourism is significant for the New Zealand economy, accounting for 10% of GDP if one takes into account its impact on other industries. We are particularly exposed relative to other countries, and the outlook for the industry is bleak, even as we make great progress in eliminating COVID-19. Domestic tourism is getting underway again, but international tourism will be MIA for a long time and is set for a slow recovery. This will weigh on incomes, spending and house prices, with some regions particularly affected. The Government is providing assistance, but pressure for more may increase, with firm closures and job losses inevitable, especially since tourism is very labour intensive. We estimate that tourism receipts could fall by half this year. However, this could reduce to a quarter if a trans-Tasman bubble were introduced. Overall, the blow to tourism could subtract 2.4% to 4.7% from GDP this year. Over the long term, the industry will reshape. But there's no denying that it is going to be a challenging time ahead for many.
Last week saw three big developments. The country took an enormous step towards normality by moving into Alert Level 2; the RBNZ at its Monetary Policy Statement scaled up QE to $60bn and left all other tools on the table; and the Government delivered a truly massive Budget, featuring a big public housing build, a targeted extension of the wage subsidy program, and a big ramp-up in health spending - and more to come, with a lot of funding as yet unallocated. We are now forecasting a further scaling-up of QE at the August MPS to a $90bn limit. This will help to absorb the bigger-than-expected program of Government bond issuance to fund all that spending. The RBNZ has received an indemnity from the Government to increase QE as outstanding bonds grow, so the hurdle has been lowered, but an expansion will still need sign-off from the Monetary Policy Committee. We expect this will happen at the August MPS, if not earlier.
This week brings a whirlwind of key events: today we will find out if we can move to Alert Level 2, the RBNZ MPS is on Wednesday, and the Budget is on Thursday. At the MPS, we expect QE to be roughly doubled, and there seems to be broad consensus in markets on that. But the risk is that the RBNZ needs to do more, with inflation expectations taking a massive hit last week. The market is looking for direction on where to next - and in particular, the likelihood of negative policy rates. In our view, there are plenty of options that are less risky and more straightforward. We see QE as the tool of choice, with plenty of scope to up the ante effectively. For the Government, it will be a "sobering" Budget to deliver and difficult choices are on the horizon. Clearly stimulus is required to cushion the blow, but it needs to be targeted to where the economic pain is being felt the most. An obvious area is tourism. Opening up the border with Australia would be helpful on that front, but not a panacea. We remain comfortable with our forecasts, with a sluggish recovery ahead, but much will depend on our progression out of lockdown and what the RBNZ and Government do. Hang on to your hats!
The labour market is rapidly deteriorating. But the full brunt of the economic impact is yet to be seen. Some businesses have had to reduce headcount already, but more job losses are unfortunately coming even as the economy reopens. Firms have been able to use wage subsidies, cash reserves and loans to delay lay-offs, but for some this will not be sustainable. Even if trade can resume in some areas, activity restrictions will be with us for a while and a significant hole in demand has opened up. The policy outlook will be critical. The Government will now lend directly to SMEs and has expanded the Business Finance Guarantee Scheme. We expect yet more fiscal stimulus in the Budget, with keeping workers in jobs high on the priority list. But the Government cannot prop up the labour market forever and a sharp rise in unemployment is inevitable. The RBNZ will also continue to do what it can to cushion the blow and support the recovery out of this crisis, meaning enormous stimulus for a long time. We expect QE to be roughly doubled, but are sceptical that negative rates will be on the cards any time soon.
New Zealand is ahead of the curve in terms of curbing the COVID-19 outbreak, and that progress puts us in a good position to open up our economy, albeit cautiously. This progress has not gone unnoticed by markets, with the NZD finding support. Yet even if New Zealand is in a relatively fortunate position, as an exporting and net borrowing nation we won't escape the global fallout of this crisis. The global outlook is grim - worse than markets are currently pricing in - and the recovery will be protracted. This weakness in demand will weigh on our export prices and the NZD. In addition, we expect to see some rise in global credit defaults, which tends to happen in downturns. This could cause a repricing of credit spreads and risk in general, weighing on the NZD. That said, positive factors are expected to stem the extent of depreciations relative to previous episodes. We are fortunate; the virus situation on our shores is enviable. But we still need to brace for economic impact.
Today we will find out if we can move to Alert Level 3 - and when. Our four-week lockdown has reaped clear benefits in terms of containing the spread of COVID-19. And it appears that New Zealand is ready to move forward cautiously and ease activity restrictions. However, the stakes are high. Moving to Alert Level 3 will have near-term benefits for economic activity and sentiment, but the economic damage will be far worse - and longer lasting - if we have to return to Alert Level 4. The details of Level 3 are consistent with our economic forecasts, which have GDP 8-10% lower this year, and QE roughly doubling. Our forecasts are also premised on more fiscal support measures coming - both now and during the recovery phase. We may see more announcements from the Government this week ahead of the Budget on May 14. CPI data out today will get less attention than usual, with the current deflationary impulse yet to emerge in the data.
As the economic landscape has shifted, so too has the Government's fiscal strategy. Government debt is expected to spike higher over the next couple of years, and some difficult decisions lie ahead for when we eventually need to rebuild buffers. For now, fiscal policy is still in the early stages of absorbing the initial blow, with more spending to come. Fiscal costs will depend on outbreak developments, the economic fallout, and policy decisions that are yet to be announced. But at this stage we expect bond issuance to increase to $45bn next fiscal year. While we are making significant progress in containing the COVID-19 outbreak, restrictions on activity are likely to be eased very cautiously. We now expect GDP to fall around 22% in the first half of the year and to be 8-10% lower over the year, with extra Government and RBNZ support. The unemployment rate is expected to lift to 11% this quarter. Consistent with a weaker economic outlook and the expected path of bond issuance, RBNZ QE is expected to roughly double to around $60bn in order to support market functioning and ease monetary conditions further.
The Government clarified this week that elimination of COVID-19, not just flattening the curve, is the goal of the current lockdown. It's an ambitious aim and we hope they succeed - everyone playing their part will be key. Eradication means greater disruption in the short term, and we are starting to see early signs of that in the economic data. But if successful, rigorous measures now increase the chances that we can get the economy going sooner, albeit in a more insulated fashion with tight border restrictions. More broadly, the economic landscape is likely to look quite different on the other side of this, and the recovery will be protracted. Some industries will benefit; some will suffer greatly. Government debt will need to be repaid; firms and households will be cautious and may look to deleverage; inflation will likely be low for some time. Expansionary monetary policy may need to be amped up more, and will be needed for a long time, even once the war is over
New Zealand is in Alert Level 4 lockdown for at least four weeks. This will save lives and benefit the economy in the longer term. We expect to see a very sharp drop in GDP in Q2, but overall a less painful economic hit than would be seen if we acted later. The path from here is enormously uncertain and there are risks of a greater economic impact if the outbreak is not contained. The RBNZ began its QE bond-buying programme on Wednesday, helping soothe markets, ease financial pressure, and provide more scope to up the fiscal response. Mortgage holiday and business finance support schemes were announced by the Government this week, and there will be more initiatives to come. But even with these responses, economic damage is inevitable. At some point down the track, focus will pivot from damage control to rebuilding - and much will need to be done. But for now, stay at home, stay safe. And for those out there working hard to provide essential services - thank you.
The global and domestic slowdown is going to be severe. This realisation has seen financial markets all but capitulate and has galvanised policy makers. Central banks around the world have moved to large-scale stimulus and taken measures to ensure financial systems remain stable. Governments are doing what they can to cushion the blow. Here in New Zealand, the Government has announced a bold fiscal package, with more to come at May's Budget. The RBNZ has cut the OCR to 0.25%, committed to keeping it there for at least a year, freed up banking system capital, provided liquidity, and are active in the market - all positive steps. And yet more is needed. We expect quantitative easing in very short order. RBNZ bond purchases are urgently needed to ease market pressure, stimulate the economy, and reduce the risk that this large economic shock coincides with a financial one.
In an encouragingly bold move, the RBNZ stepped up to the plate and delivered an emergency 75bp OCR cut this morning, committing to keep the OCR at 0.25% for at least the next 12 months. Next, we expect unconventional policy will be deployed as soon as is practicable, with large-scale asset purchases on the cards. To support credit creation, the RBNZ has also delayed increases in capital requirements. A significant fiscal package is expected tomorrow. We are looking at a rapid and widespread global demand shutdown that is putting financial markets under extreme pressure. Bold New Zealand border controls and other looming containment measures will frontload a massive economic blow in order to lessen the odds of a much worse one. It’s absolutely the right thing to do and the pain was inevitable, but businesses will be hit hard, and we have a widespread drought to boot. A domestic recession is guaranteed, and it won’t be shallow.
The global policy response to COVID-19 has ratcheted up significantly this past week with central banks slashing interest rates and governments pledging funds to mitigate the fallout and facilitate the response. We expect the RBNZ will cut the OCR 50bps at, or possibly before, its next Review on 25 March. We see the OCR reaching 0.25% by May, but think the RBNZ should tread very cautiously from there, given the risk that credit availability is impaired when policy rates go super low or negative. This is important, as banks have a key role to play in helping firms and households get through. The risk that unconventional monetary policy will be required is lifting. And it’s time for the Government to up the ante on fiscal policy. The good news is that there is plenty of firepower to do this. Scrapping this year’s minimum wage rise seems like a no-brainer given pressure on businesses, and there are plenty of other short‑ and long-term policy options that could help.
We now expect the RBNZ to cut the OCR 50bp in March and a further 25bp in May, taking the OCR to just 0.25%. The COVID-19 situation is evolving very rapidly, spreading fast outside China - including, now, in the US - and the virus is now present in New Zealand, although it appears to be isolated so far. A marked global slowdown is guaranteed, due to both demand and supply disruptions. Our forecasts assume New Zealand GDP stalls in the first half of the year, with a gradual recovery from there. But although New Zealand is better placed than many countries to weather this shock, we see clear risks of a larger slowdown or even recession. Fiscal policy will need to do the heavy lifting, but lowering the OCR will ease financial pressure, facilitate a lower NZD, aid confidence at the margin, and support the recovery.
The outbreak of COVID-19 continues to upend both lives and economies. Here in New Zealand, exporters of goods and services have borne the brunt so far, but are well-placed to weather a short period of disruption. The longer the interruption to China's economy continues, however, the more we'll start to notice it on the import side - not just toys and electronics. China is also a key supplier of a range of intermediate and capital goods that are crucial for construction, manufacturing and farmers. For now, it's an air bubble in the supply pipeline, but it could become a bigger issue if it persists. It remains impossible to put a timeline on China returning to normality. We've updated our GDP forecasts to take into account the latest developments. We now expect -0.1% growth in Q1, and 0.5% growth in Q2. Key data this week are reads on both business and consumer confidence.
Low interest rates have spurred demand for credit, but bank deposit growth has been declining. The latter may reflect a search for higher returns, reduced foreign buying of assets, and/or increased cash use. It’s difficult to disentangle the drivers with any precision, but the slowdown in deposit growth matters. New Zealand banks need deposits to fund their lending, so the recent widening in the bank “funding gap” is something we are watching closely. In the current environment, generating deposit growth may be difficult – although banks can tap non-deposit funding, this has its limits. Closing the gap is likely to result in a tightening in credit conditions, at least to some degree, at a time when credit demand is strong. A significant economic headwind could be in the pipeline.
It’s MPS week. We’ll be watching for a steer on how the RBNZ is thinking about the known and unknown economic impacts of China’s novel coronavirus outbreak. RBNZ comments will no doubt highlight the enormous uncertainty of a fast-moving situation. The devastating human toll of the virus is centred on the city of Wuhan, but it is disruption at China’s ports that is taking a large economic toll on the New Zealand economy at present. This will hopefully be resolved very quickly, but it is just round one, with exports of tourism and education services already affected, and the extent of damage to China’s economy unclear. This week we use the information available to assess the possible implications for the near-term economic outlook. Uncertainty is extreme, but it hopefully provides a framework to think about the economic implications of developments as they unfold.
The human impact of the new coronavirus is very worrying and our thoughts are with those affected. From an economic perspective, it is far too early to gauge the impacts, but New Zealand could be affected through a range of channels and we are watching developments closely.
Stepping back, this week we explore some of the possible channels through which climate change may impact our economy. In the short term, the most significant effects are being felt as a result of regulatory changes. But looking forward, changing consumer preferences and investment decisions will contribute to a changing economic landscape, and direct impacts of environmental conditions will be increasingly felt. Overall, the economic effects are highly uncertain, but change is inevitable, and the transition presents costs, opportunities and risks
The NZD-TWI exchange rate moved higher in recent months, though it remains below levels seen a year ago. We expect news of the new Wuhan coronavirus will weigh in the short term, but developments beyond that are hugely uncertain. Assuming it is contained, over the coming year, we see the OCR on hold for now, with the NZD expected to hover close to current levels, held up by export prices, global monetary stimulus and improved risk appetite. Policy easing from some other central banks will be supportive, but we see upside as limited, with the domestic outlook largely priced in. If the NZD did move higher, we don’t think it would perturb the RBNZ provided it was consistent with a positive data story, even if it softened the outlook at the margin. All of that said, the currency outlook would change rapidly if risks were realised and we saw a large global shock. But in that case, the whole economic landscape would change too.
We've updated our OCR call, removing the cut we had pencilled in for May. Our central forecast is now for a flat OCR track. Since the November MPS, forward-looking activity indicators have improved, the Government has announced more spending is in the pipeline, the housing market has strengthened, and inflation looks like it is sitting close to target. It's true that revisions mean that GDP decelerated more sharply over 2019 than previously thought. But momentum appears to be stabilising, and it now looks more likely that the economy will be able to generate growth around trend over the medium term, despite headwinds. The RBNZ has scope to be patient and await further signals on the economic direction. Downside risks have not gone away - we see the market's pricing of a decent chance of further cuts as entirely appropriate - but a near-term cut would require an abrupt change of circumstances. Our full set of forecasts will be updated in our ANZ Quarterly Economic Outlook on 28 January, following the release of Q4 CPI.
A new year is upon us. Unfortunately we don't have 20/20 vision when it comes to the 12 months ahead; if we did, we'd be traders, not economists. But still, it's useful to kick off the year by taking a big picture look at what we'll be watching closely - including some of the tail-risks that could mean our forecasts are completely wrong. First up, we should acknowledge that over a one-year horizon, the fate of the NZ economy isn't entirely in its own hands. The weather, natural disasters, commodity prices, global geopolitics, global credit markets and the NZD could all have a say in how the economy performs, but it's a case of rolling with the punches. In terms of things that actually reflect our choices and policy settings, we'll be watching credit availability, business sentiment activity indicators, the details of the Government's infrastructure spend-up, the housing market, and indicators of resource stretch and inflation pressure in the economy. This week we kick off with the QSBO and a range of inflation indicators, as well as reads on housing and manufacturing.
With the holiday period almost upon us, we reflect on the year that has been and the outlook for the year ahead. The economy slowed largely as we expected this year, with Q3 GDP this week expected to show 2.3% y/y growth. But a gentle turning point may be around the corner, with leading indicators looking a bit brighter. And the Half-Year Update last week promised additional infrastructure spending, but this won't ramp up meaningfully until 2022 and beyond - too late to support near-term growth and inflation pressures. Monetary policy has done the heavy lifting this year - the RBNZ delivered 75bp of OCR cuts, a bit more rapidly than we expected. But we think there's still more work for the RBNZ to do to support employment and lift inflation expectations. We expect one further rate cut, taking the OCR to 0.75%, in May next year.
As we head into the summer months, the economic outlook is looking a little brighter. This week, the Government looks set to commit to further investment spending. Last week, the RBNZ announced its bank capital decisions, and the changes announced were softer than those initially proposed, meaning they are likely to be less of a headwind to the economy than previously thought. We've also seen a lift in business sentiment, a pick-up in the housing market, and robust commodity prices. Reflecting these more positive developments, we have changed our OCR call to only one 25bps cut in May, removing our August placeholder cut for the bank capital changes. However, while things are looking a little sunnier at the margin, we still think the RBNZ will conclude that a bit more monetary stimulus will be required eventually. The economy still faces a number of headwinds and clouds are expected to form on the horizon in time.
Is the economy at a turning point? Recent developments have certainty been more positive, with business and consumer confidence lifting, the PMI rebounding into expansionary territory, and the housing market picking up. The Government is sounding more amenable to spending a bit more. Our commodity prices are holding up well and global financial market sentiment has lifted, but the hard data is yet to confirm a global growth turnaround. Overall, these developments are consistent with our forecast for growth to stabilise around 2%, but the bank capital decision this week may add a further headwind. We're not out of the woods, but the risks now feel more balanced than a few months ago. That said, we think that beyond the near term the RBNZ still has more work to do to get inflation up to 2% sustainably - we're picking cuts in May and August, taking the OCR down to 0.5%.
The RBNZ has recently conducted its regular health check of the New Zealand financial system. The test results, diagnosis and prescription will be announced in this week's Financial Stability Report (9am Wednesday). We expect the risks to financial stability from high household sector debt to again feature. And given that the pulse of the housing market has recently picked up, we think the balance of risks has shifted towards the RBNZ keeping LVR restrictions unchanged for now. But it's still a close call. Like us, we think the RBNZ will be cognisant of the possibility that house prices could take off strongly again, which would not be ideal from a financial stability perspective (among others!). Dairy sector debt and international risks should also feature heavily. The former appears to be on an improving trajectory; the latter are little changed since May.
The RBNZ, RBA, and the Federal Reserve have all now joined the Texas Hold'em club, betting - for now - on previous rate cuts doing the job. Most analysts and the market had been expecting one more cut from the RBNZ last week, taking the OCR to an RBA-matching 0.75%. But while the RBNZ did significantly downgrade their near-term outlook, as expected, a lower TWI and a downward revision to their estimate of how fast the economy can grow offset that. There are still aspects of their medium-term outlook that we see as too optimistic, and the RBNZ has yet to take into account the bank capital changes, to be announced 5 December. We are now forecasting two further cuts in May and August next year, taking the OCR to 0.5%. The risks are tilted towards earlier and/or more cuts, depending partly on the outcome of the RBNZ's capital proposals, but also global factors.
It's not the slam dunk it was, but on balance we think the RBNZ is set to cut the OCR to 0.75% this week. On the positive side, the NZD has fallen, house prices have strengthened, and Q3 CPI inflation was a touch stronger than expected. But dominating that, the outlook for both global and domestic growth has weakened markedly since August, despite the more positive vibe in the past month. And looking ahead, the impact of higher bank capital requirements will need to be added into the forecasts for the February MPS. Putting it all together, the path of least regrets would be a 25bp cut in November, taking the OCR to 0.75%, and leaving the door ajar to more if required. We continue to expect 25bp rate cuts in November, February, and May, taking the OCR to 0.25%.
4 November 2019:Is less growth always a bad thing? (PDF 644kB)
Leading indicators suggest that near-term growth will be weak, adding downside risk to even our subdued GDP growth forecasts. We're expecting just 0.1% employment growth in the Q3 data out on Wednesday, though the labour market clearly remains 'tight'. But, taking a step back, there's increasing debate: is endless economic growth really what we should be aiming for? GDP growth is a limited measure of human wellbeing and a spectacularly bad one of the earth's wellbeing. That isn't what it was designed for, of course. But the trade-offs between growth and the environment, and living standards today and tomorrow are not going away. Quality over quantity of growth will be the key. Governments have a key role in driving innovation and shaping future directions that can reduce the trade-offs.
On the whole, the New Zealand economy hasn't built up the same vulnerabilities over this cycle as has been typical. Our national debt funding profile is longer term and more resilient; the current account deficit is contained; our net international investment position has improved; and credit growth has been relatively modest. We can thank a mix of good luck and good management. It's not all wins - we've run a goods trade deficit for the past four years, and household debt is at a record high. But overall, the current expansion is looking more sustainable than some we've had, and the system is less likely to experience a disruptive outflow of foreign capital than in the past. All up, the New Zealand economy is looking less risky, but certainly not riskless.
Inflation moved further below 2% in Q3, falling to 1.5% y/y. The RBNZ may find a glimmer of hope in the surprise rise in domestic (non-tradable) inflation to 3.2% y/y, but we think it should be discounted. A decent whack of domestic price increases recently have been driven by factors that the RBNZ quite rightly "look though" (ie regulated prices). Consistent with that, core inflation measures moved broadly sideways, stuck below 2%. Inflation is a lagging indicator anyway, and the growth outlook has deteriorated, suggesting that inflation pressures will ease. All up, the latest rise in domestic inflation will be welcomed by the RBNZ as it reduces downside risks to inflation expectations. But there's still plenty to keep the Monetary Policy Committee up at night.
The RBNZ has recently sent the Government a friend request, noting there's scope for fiscal policy to support the economy and the RBNZ's inflation and employment objectives. In the past, when monetary conditions are tightening, fiscal policy has been constrained by the consideration that any extra stimulus will likely end up being crowded out by higher-than-otherwise interest rates. But now, the OCR is low and going lower, the economy isn't firing on all cylinders, inflation pressures appear contained and poised to wane, and the Government has the firepower to lend a hand. So should the Government do a little more to help keep monetary policy in conventional territory? Or should it keep its powder dry just in case one of those nasty tail-end risks to the economy materialise? We think a little more wouldn't hurt, and that the Government is likely to reach the same conclusion, meaning some additional fiscal stimulus is one of the few upside risks to the outlook at present.
The QSBO survey for Q3 was very weak, adding downside risk to even our subdued growth forecasts. So what is going on? Global growth is clearly cooling, but New Zealand has been largely shielded so far - at least our commodity prices have been. But tourism is feeling it, as is business sentiment, and that's starting to hurt investment and employment. And export intentions indicate trouble. Net migration estimates are holding up, but we see some risk it could be revised lower - meaning lower net migration might have been a bigger part of slowing growth than is currently recognised. What about the supply side? Domestically, firms are still concerned about capacity constraints, but there are signs that this is easing, with some indicators suggesting labour is becoming less difficult to find and weaker demand is becoming a greater issue. Amidst all this, the household sector is still holding up. But if they seriously retrench, it's game over.
30 September 2019:Dead or just sleeping? (PDF 552kB)
Last week the RBNZ held the OCR at 1% and noted that there is scope for more cuts if necessary. The RBNZ also stated that low long-term interest rates reflect low expected inflation well into the future. Indeed they do. But what if the RBNZ (and us, and everyone else) is wrong and the story of the next decade is sharply higher inflation? This week, we explore a tail risk that no one is talking about. There are several potential catalysts for a return to a high inflation, low growth world: oil price shocks, tariffs and protectionism, or climate change. These ‘supply shocks’ could have a potent impact if they cause a rise in inflation expectations. Global central banks’ independence is steadily eroding – could the commitment to inflation targeting come into question? Our forecasts – everyone’s forecasts – are based on the status quo. But the status quo is coming under pressure.
This week we expect the RBNZ to leave the OCR on hold as it waits to see the impact of its actions so far, but by November we think they'll be cutting again. "Lower for longer" is our forecast, and most other forecasters are broadly on the same page, though not yet calling the OCR as low as we are (just 0.25% by May next year). But retail interest rates and wholesale interest rates are not the same thing, and they do not always move together, as we learned in the Global Financial Crisis. There are plausible scenarios around both global risk appetite and bank capital requirements that could see at least some retail interest rates rise, even if the economy fails to bounce back. Broad agreement amongst forecasters that the OCR is going to be low for a long time does not mean there is no upside risk to the interest rate borrowers face.
We recently revised our forecasts for the OCR to a new record low of just 0.25% by May next year. The single most important driver of this change is a downgrade to the outlook for growth in the second half this year, with the biggest revision being to business investment. But it isn't all doom and gloom by any means - parts of the economy are doing just fine. The issue is that the RBNZ needs the economy to run hot, not in the kind of spluttering fashion we expect. There are still solid supports out there which we expect will see the growth rate modestly pick up next year. But with inflation under target and inflation expectations slipping, the RBNZ will conclude it can't afford to be patient.
We now expect the OCR to hit 0.25% by mid-next year, and with the global outlook shaky, a negative OCR certainly can't be ruled out. This week we look at some of the international experiences with negative interest rates to glean insights into what it would mean. The good news for households is that they are unlikely to be directly exposed to negative interest rates on their savings accounts. But banks and cash-rich businesses do bear the costs. Ever-lower policy rates don't always mean lower lending rates, and it isn't clear that negative interest rates will be successful in boosting inflation expectations. Negative rates also severely disrupt the normal workings of the banking system. So while a negative OCR is an option in the RBNZ's toolbox, we're not at all convinced that it should be deployed.
As a small open economy, New Zealand is at the whim of global forces. Recently, the global growth outlook has deteriorated further and trade tensions have escalated dramatically. We step through three key channels which New Zealand has been impacted through; trade, financial markets, and uncertainty. So far, tourist numbers are weaker but our exports and commodity prices have been shielded by continued demand for soft commodities and favourable supply factors. The NZD is doing its job and global financial conditions are looking more fragile, but are still a tailwind. But elevated global uncertainty seems to be weighing on domestic firms' sentiment, investment and employment. Overall, the risks are all looking pretty one sided.
The OCR has already been cut 75bp this year to 1.00%. We expect a further cut to 0.75% in November, with the risks being skewed towards sooner and/or more. But there are signs that the OCR is already losing a degree of traction on bank lending and deposit rates - one of the key channels through which monetary policy affects the economy. Diminishing pass-through to bank funding costs/deposit rates (and hence lending rates) adds to the risk that interest rates in New Zealand may already be approaching the effective lower bound in terms of their impact on mortgage and other borrowing interest rates, though not via other important channels such as the exchange rate.
Aging demographics are going to pose significant challenges in the decades ahead, for New Zealand and the global economy. Favourable demographics have been a tailwind for the global economy since the 1970s, as baby boomers transitioned through the workforce. But now, the tide has turned. In some economies, the change is going to be significant - in China in particular. Looking ahead, an aging population globally implies lower GDP growth rates, lower interest rates, and greater debt burdens. In this new world, central banks need to prepare for what happens when policy rates hit zero (if they haven't already), and governments need to prepare for the fiscal burden of greater health and superannuation costs.
Last week was packed full of surprises. Globally, China allowed the yuan to depreciate through 7 to the USD, trade tensions rose, and global markets fell sharply. Amid the financial market turmoil, we added another 25bp cut for September to our forecasts, implying an OCR of 0.75% by year-end. Meanwhile, the Q2 unemployment rate unexpectedly dropped from 4.2% to 3.9%. Then came the RBNZ; they decided to load our August and September 25bp cuts into one big 50bp hit in August, cutting the OCR to 1% and signalling that it could go even lower. We still expect a November cut to take the OCR to 0.75%, but note that September remains live with this pre-emptive Committee at the helm.
It's all action this week with Q2 labour market statistics and the RBNZ's August MPS in the spotlight. We round up some of the key developments that the RBNZ will have to consider, and it's not looking pretty. The global growth outlook has worsened, overseas central banks have eased policy (putting upward pressure on the NZD), commodity prices have softened, the outlook for domestic growth has weakened, unemployment looks likely to increase, and inflation expectations are at risk of slipping further. We expect the RBNZ to cut the OCR to a new record low of 1.25% on Wednesday, and signal that an even lower OCR is likely needed.
New Zealand's trading partner growth has slowed over the past year or so. While goods exports have so far proven resilient, there are a few signs that this weakness is weighing on services exports, particularly international tourist arrivals (especially from China and Europe). However, before we go sounding too downbeat, it's important to note that capacity constraints are a factor too. Transitioning from volume-driven growth towards greater value-add is something the sector was going to have to do at some point. So long as downside tail risks to the global outlook don't materialise (spooking foreign households), international tourism should be able to weather softer global growth, particularly at the higher (less price-sensitive) end of the spectrum.
CPI inflation in the second quarter offered no surprises, coming in bang on ANZ and RBNZ expectations. But the outlook for domestic inflation is bleak, with renewed slack in the economy set to drive annual non-tradable inflation lower. And the recent dip in inflation expectations poses a key risk to the inflation outlook. While we estimate that inflation expectations will stabilise around the target midpoint of 2%, we would expect the RBNZ to react aggressively were surveyed inflation expectations to start to slide from here, so it's worth keeping an eye on this data.
Yiel22d curve inversion (long-term interest rates lower than short-term ones) is often touted as a possible precursor to economic recession. The US Federal Reserve assesses the probability of a recession using this indicator, and as at 30 June this was implying that the chance of a recession occurring in the US economy over the next 12 months is 33%. However, how much this indicator should be trusted is hotly debated. It's got a great track record, but there have been lots of weird things going on in interest rates and monetary policy this decade that may have invalidated it. Here in New Zealand, its track record isn't so good, so we aren't reading too much into the inversion that has also been seen here. But clearly there are expectations of interest rates being lower for longer. This will stimulate the economy, but as interest rates get ever lower, the offsets get stronger, including the negative impact on savers and bank margins, impacting credit availability. We expect it'll take a couple more cuts before the RBNZ is comfortable with the medium-term inflation outlook.
Global manufacturing has been under pressure for a while now as slowing global trade (on the back of US-China trade woes and waning US fiscal stimulus) has weighed on demand. While New Zealand’s export commodity prices have held up, our ex-food manufacturing sector has slowed alongside the wider domestic economy, suggesting New Zealand’s experience may not be so different. Indeed, last week’s Quarterly Survey of Business Opinion suggests slowing manufacturing activity (and the wider economy for that matter) has persisted into Q2, and that this may now be leading to reduced headcount in the sector – and hence a possible (but likely small, so far) spillover into household incomes. This week brings a scattering of monthly data releases, with a few partial Q2 CPI indicators (June food prices, rents, and our Monthly Inflation Gauge), our Truckometer, cards transactions (which isn’t very useful data), the June PMI and possibly REINZ housing market data.
The global economic outlook has deteriorated over time, but the global monetary policy landscape has changed more abruptly, with further stimulus signalled by key central banks including the US Fed. Global bond yields have dropped dramatically, and local yields have gone with them. This is an important context for the RBNZ's dovish OCR Review last week, in which they said more OCR cuts were "likely". Although the RBNZ sets the OCR for New Zealand conditions, the importance of interest rate differentials for the NZD means that what other central banks are up to matters. But that doesn't mean we need to keep pace 1:1. The RBA has more immediate work to do than the RBNZ; ANZ is forecasting policy rate cuts tomorrow and August there, whereas we expect the RBNZ to cut in August and November. We also expect two cuts from the US Fed in the second half of this year.
With the OCR at just 1.5%, it's time to acknowledge that if things were to take a decisive turn for the worse, we could end up following in the footsteps of central banks overseas, with negative interest rates and/or quantitative easing. It is far from a given that going down this path would be necessary - or wise. Fiscal policy and the NZD would be expected to do the heavy lifting. And the effectiveness of such policies abroad is debateable, with real costs and risks. But if unconventional monetary policy is risky, doing it on the fly would be riskier still, so it's time to plan ahead. This week brings the Reserve Bank OCR Review. While the domestic data has evolved broadly in line with their forecasts, the global picture has turned sourer and other central banks have turned decisively with it. How these two factors will be weighed up is uncertain. We expect a more dovish tone but stopping short of promising further cuts, but we can't rule out the RBNZ will elect to follow the crowd rather than risk upward pressure on the NZD.
Q1 GDP is out this week, so what better time to discuss the broader economic outlook? For the record, we expect economic activity expanded 0.4% q/q in Q1, which would see annual growth slow 0.1%pt to 2.2%. But even if Q1 growth surprises on the upside, it won’t change the broader theme that economic momentum is waning and that core inflation is still not quite where it needs to be. To rectify this, and given growth headwinds aren’t expected to dissipate anytime soon, we think a little extra monetary stimulus is likely to be delivered by year-end. As well as GDP this week also brings Q1 balance of payments data, which we expect to show a stable current account deficit as a share of GDP. Our Monthly Inflation Gauge for May is out today, and there’s another dairy auction on Wednesday.
The OCR, at 1.5%, is now at a record low. The RBNZ’s pre-emptive cut has been effective in easing financial conditions in New Zealand via both a lower NZD and a drop in lending rates. While this will provide a tailwind to growth, other headwinds are evident. Businesses are reluctant to spend and invest, the residential construction outlook is looking increasingly precarious, and global growth is faltering. There is also a risk that financial conditions could tighten sharply over the next year. We think that more OCR cuts will be needed to ease financial conditions further and ensure that monetary policy supports a gradual recovery in growth, inflation, and employment.
Last week was busy. The Reserve Bank’s Financial Stability Report (FSR) was released, the first Wellbeing Budget made its debut, and ANZ’s Business Outlook and consumer confidence surveys were out. “Resilience” was the theme of the week. The FSR argued the financial system was resilient but more work needed to be done given still-elevated risks. The Budget maintained a focus on fiscal resilience in anticipation of a rainy day, while boosting spending with a broader focus on what matters. Only the Business Outlook arguably didn’t rise to the occasion, with businesses seemingly not feeling very resilient at all. Global markets aren’t feeling too robust either, with a stampede for the relative safety of bonds seeing global yields fall, including here in New Zealand, where the 10-year bond yield hit record lows.
It’s Budget week. The Government’s books are in a healthy position, but a slightly softer economic outlook will likely drive a small deterioration in the fiscals from six months ago. But we think there will be enough wiggle room to accommodate that, and the forecasts will continue to show net debt at (or slightly below) 20% of GDP by 2022. Once achieved, the Government has signalled it intends to maintain net debt within a 15-25% of GDP range. This wouldn’t kick in until after the 2022 fiscal year, and is unlikely to have much impact on the 2023 fiscal year forecasts (at this stage). From a macroeconomic perspective, we don’t think the RBNZ will find much in the fiscals that suggest a stronger inflation impulse than they’ve already baked in. The RBNZ’s Financial Stability Report is also this week, as well as the ANZ Business Outlook and consumer confidence surveys.
The recently released Climate Change Response (Zero Carbon) Amendment Bill proposes to tackle climate change by committing to long-term targets, introducing an Independent Climate Commission, and ensuring the Government develops carbon budgets and policy plans to meet these. For dairy farmers, the Bill adds another layer of uncertainty to an already challenged sector. Options that may help the sector achieve the proposed targets include livestock reductions, farming more efficient stock, and technological improvements, such as using feeds that result in lower methane emissions. Coming up this week, dairy prices, overseas goods trade, and Q1 retail sales are due.
The RBNZ cut the OCR 25bp to 1.50% at the May MPS last week, citing slower global and domestic growth. But it wasn’t all guns blazing: the forecast OCR track implies only a 50% chance of a further cut (sometime next year). The RBNZ downgraded their near-term outlook substantially, with GDP growth slowing to 2% y/y by Q2 2019 (in line with our forecast), implying the hurdle is high for a further cut on domestic factors in the near term. However, beyond Q2 the RBNZ is forecasting a strong cyclical lift in annual GDP growth that looks optimistic compared to our own forecast. Accordingly, we continue to expect a further OCR cut in November, with one more cut to follow early next year. This week we’ll get another read on the housing market from REINZ and an update on migration.
The wait will soon be over for the much anticipated May Monetary Policy Statement (out 2pm Wednesday). Since the RBNZ’s dovish shift in guidance at the March OCR review, market pricing has been quite appropriately ebbing and flowing around the 50% mark for a cut in May. More analysts than not are now calling a May cut, but we’re not among them. On balance we expect the Bank to deliver a dovish hold, presenting a downward-sloping OCR track and firming up its language around the likely impending need for additional monetary stimulus. By August, we think the evidence that slowing economic momentum and waning capacity pressures will be sufficiently strong for the RBNZ to cut the OCR, but we certainly wouldn’t rule out that they’ll decide to bite the bullet next week. It’s a nail-biter. There’s also three ANZ proprietary indicators and another GlobalDairyTrade auction out this week.
In the March OCR Review, the RBNZ surprised the market with a dovish tone, explicitly referring to the risk of a higher NZD. But since then, the NZD has fallen a lot, accompanied by expectations for a lower OCR. Interest rate differentials and relative terms of trade have been important drivers of the NZD/AUD and NZD/USD crosses recently. A lower exchange rate is an important channel for the RBNZ, and recent falls should add to inflationary pressure if the RBNZ locks them in by retaining its dovish tone and showing OCR cuts are expected. To keep the stimulus from recent falls in the NZD and mortgage rates flowing, we expect the first OCR cut will be delivered in August, with two cuts to follow. This week brings the final pieces of the domestic data puzzle ahead of the May MPS, with the ANZ Business Outlook Survey on Tuesday and Q1 labour market statistics on Wednesday.
Our latest economic outlook has annual GDP growth slowing to 2% in Q2 2019. However, still-high (but easing) net migration inflows, expansionary (but not persistently) fiscal policy, low interest rates, and an elevated terms of trade should put a floor under the deceleration. Capacity pressures are poised to continue to wane and that’s going to weigh on non-tradable inflation. However, with OCR cuts expected from August, it shouldn’t be long before the economy gets the stimulus it needs to push economic activity back into inflation-building territory. It’s a pretty quiet week ahead data-wise, with ANZ-Roy Morgan Consumer Confidence for April and Overseas Merchandise Trade for March both due out on Friday.
The minimum wage went up $1.20 on 1 April to $17.70 per hour, and is now sitting at almost 71% of the median wage. And more rises are on the way; the Government intends to keep lifting the minimum wage to $20 by April 2021. This week we provide an overview of the outlook for the New Zealand labour market, and discuss how minimum wage rises are likely to impact economic outcomes. All up, we expect higher minimum wages to provide a small temporary boost to real wage growth, but higher CPI inflation than otherwise will provide a partial offset. Lower-than-otherwise hours worked will also partially offset the boost to household incomes. Speaking of inflation, this week brings the Q1 CPI release. Annual headline inflation is expected to tick down to 1.7% owing to softer tradable inflation. Non-tradable inflation is expected to tick up a touch, in line with RBNZ expectations.
New Zealand’s primary industries are an important part of the economic picture. Commodity prices are generally strong at present. However, rising costs are impacting returns, with finding skilled labour a particular challenge. There are varying conditions across segments, and this is evident in confidence levels. High debt levels in the dairy sector are curbing market sentiment, with farmers focused on debt repayment and required investment. Meanwhile, confidence in horticulture and sheep and beef industries is strong on the back of elevated returns. And so far, slowing Chinese growth is not affecting the forestry sector. That said, a slowdown in global growth is clearly evident, and there is a risk that conditions could deteriorate for primary producers, particularly if gravity comes calling for our commodity prices. Global risks are clearly weighing on the RBNZ’s thinking and they have indicated that the next move in the OCR is more likely to be down.
The Reserve Bank surprised all punters by saying that “the more likely direction of our next OCR move is down”. In response, the NZD dropped about a cent, and yields dropped sharply across the curve. We have been saying since late last year that the next move in the OCR would be down, but the RBNZ has come around to our view sooner than we had anticipated. However, acknowledging that downside risks to the growth outlook imply downside risks to the OCR is one thing; actually cutting the OCR is another. It is a line-ball call, but on balance we think the RBNZ will wait to see global and domestic risks manifest into something more concrete before actually cutting, in order to rule out the possibility of the unnecessary volatility in interest rates and exchange rates that a U-turn would engender. We have therefore brought forward our OCR rate cuts by three months to August, November and February, giving the RBNZ one more Monetary Policy Statement, in May, to assess how things lie (and introduce the new policy committee members). But between now and then lie several key data releases, and a decent disappointment in any of them could result in a cut as soon as May.
Last week’s GDP data showed growth continuing to moderate, slipping from 2.6% to 2.3% y/y. We expect the RBNZ will acknowledge this softening at the OCR Review this week but maintain an overall similar tone to the February MPS. Near-term GDP indicators point to ongoing softness and the RBNZ’s forecast for growth above 3% y/y this year is looking hard to achieve. That said, there is scope to wait and see how developments unfold. Moving forward, the RBNZ’s view on how potential output evolves – based on its assessment of capacity pressures – will be crucial for the inflation and policy outlook. Currently, the economy is coming up against constraints, but we expect that these will start to wane as headwinds build, making it difficult to sustain inflation at the 2% target over the medium term. Once that eventually becomes apparent, we expect the RBNZ will lower the OCR. We continue to pick November for the first move, though there are risks that could see this happen earlier or later than we expect.
Drivers of economic growth have shifted and this has been reflected in a changing economic landscape regionally. It’s currently a mixed picture. Auckland and Canterbury are not the engines of growth they once were. Conditions in Wellington are very favourable. Meanwhile, a number of provincial areas, like Northland, Bay of Plenty, Hawke’s Bay, Otago and Southland have been hot spots – boosted by favourable conditions in agricultural segments, strong tourism, buoyant housing markets, and population growth. However, challenges such as low confidence in the dairy industry are weighing in some areas. Despite regional divergences and strong performance in some places, businesses across a range of regions are wary about the outlook – and there is a risk that the landscape could shift from here.
Globally, manufacturing output is slowing, but New Zealand manufacturing is a clear outlier. This reflects the fact that volumes have been supported by meat and dairy production, which in the short run tends to be driven more by the weather than demand. Global demand fluctuations do turn up in meat and dairy export values, via commodity prices. But so far these have held up remarkably well to the slowing in global growth. Outside of meat and dairy, manufacturing growth has softened. Fluctuations in export demand tend to flow through to volumes, while domestic consumption of manufactures tends to be heavily influenced by construction. While it is possible that New Zealand manufacturing may continue to outperform international peers, downside risks are accumulating and acceleration in growth from here seems unlikely.
Statistics New Zealand have recently changed how they measure net migration, with the new data suggesting the resident population comprises around 50,000 fewer people than previously thought. This week we take a closer look at these data and discuss how they have affected our understanding of New Zealand’s recent economic performance – and what that could imply for the outlook. All up, we don’t think implications for how we view the economy will be large. But one thing’s for sure, the susceptibility of these data to large revisions will make it difficult to gauge the pulse of the migration cycle – an important element of domestic demand in the economy – in anything remotely resembling real time. The week ahead brings the last of the major Q4 GDP partials: wholesale trade, the economic survey of manufacturing, and the value of building work put in place. So far we’re seeing some mild downside risk to our preliminary pick of 0.6% q/q for GDP growth.
The much-awaited Tax Working Group final report was released last week, recommending that the taxation of capital income be extended, alongside reduced income tax for those on lower incomes. Taxing capital gains would have fairness benefits, potentially lead to increased portfolio diversification, and make property investment less attractive. But the report acknowledges it could also hamper investment, push up rents, and negatively impact savings and productivity. Plus, it would not solve our housing affordability problem. While a capital gains tax has now passed the first hurdle, there is no guarantee it will be embraced by politicians, especially in its current form. And even if the current Government decides to run with it, we will not get clarity on the issue until after the 2020 election. The decision of whether to implement or not may ultimately be up to voters.
The Reserve Bank last week sounded a slightly more cautious tone about the future path for the economy and inflation than in their November projections, but only modestly so. The implied first OCR hike was pushed out to mid-2021 from late- 2020. The market was anticipating a more significant change in tone, perhaps influenced by dovish surprises from the US Federal Reserve and the Reserve Bank of Australia. This meant the NZD and interest rates spiked on the day, even though the surprise relative to most economists’ expectations (including ours) was small. Our expectation for OCR cuts kicking off in November is built on a forecast that GDP growth will fail to accelerate over this year as the RBNZ is projecting, leading to the RBNZ in time concluding that more monetary stimulus is required. There is plenty of data between now and then to make or break our case.
The RBNZ Monetary Policy Statement is this week’s headline act. Since November, the labour market has flat-lined and the growth outlook has a duller pitch, though domestic inflation has been a little stronger. Global data has struck a softer note and risks have increased sharply, with central banks turning more dovish in concert. We expect the RBNZ will join the chorus this week, employing a similarly dovish tone that echoes the tenor of other central banks and market pricing, which has moved to price in a good chance of a rate cut, reflecting the changing balance of risks. That said, a dovish stance so soon from the RBNZ is not a necessary ingredient of our November cut call. The data and market pricing may well strike higher and lower notes, but we think the case for more monetary stimulus will become evident in time.
The outlook for inflation is nuanced at present. Core inflation has been inching up, but non-tradable inflation remains shy of where it needs to be. The RBNZ were surprised to the upside on Q3 non-tradable inflation. But potential growth may be higher, meaning GDP needs to remain strong – and we think that will be a challenge. As such, capacity pressure may be past its peak at a time when firms are still grappling with lack of pricing power, weighing on inflation. From the Reserve Bank’s perspective, capacity pressures still look pretty reasonable, inflation is still tracking up towards where it needs to be, and there are risks in both directions – meaning they can bide their time and wait and see how things unfold. We think that the RBNZ will eventually come around to our view that more monetary stimulus will be required, but probably not just yet.
Our latest economic outlook sees annual growth averaging 2.5% over the next couple of years. While this is still a respectable pace of expansion (given it’s off a high base), inflation pressures are not expected to intensify in this environment. Gradually tightening credit conditions, owing to confirmed and probable changes to bank capital requirements, add to an already lengthy list of headwinds the economy is expected to face (and in large part, is grappling with already). We see the case for OCR cuts becoming more evident in time, and have pencilled the first in for November. However, we acknowledge that the path ahead may not be a straight one, with market pricing ebbing and flowing with the data (the solid print for Q4 non-tradables inflation last week comes to mind). It’s a pretty quiet week ahead data-wise, with Overseas Merchandise Trade for December (out today) the main event.
The QSBO experienced trading activity data last week joined the Truckometer in suggesting that momentum in the New Zealand economy is coming off the boil. Slowing population growth, labour shortages and squeezed profitability are all contributing. Growing off a strong base is harder, of course, and the data is still consistent with growth in a 2-3% range, a soft landing by anyone’s standards. But it’s worth taking a sideways look at the darkening clouds gathering around the global outlook. Fair to say the news on global manufacturing and trade has been pretty one-sided of late. But other sectors are looking more robust and New Zealand’s commodity prices are so far proving remarkably resilient. The highlight of the domestic data calendar this week is Q4 CPI inflation – we expect 0.0% q/q and a slight easing in annual CPI inflation to 1.8%.
Just before Christmas we changed our OCR call. We are now expecting the RBNZ’s next move to be a 25bp cut in November, with two follow-up moves taking the OCR to a record low of 1.0%. There are several reasons for our call. First, while we have not revised down our growth forecasts meaningfully, there are signs of waning momentum, in both the Q3 GDP result and forward-looking indicators. Upward revisions to GDP mean that the RBNZ is likely to conclude that a solid growth rate will be required to deliver inflation sustainably back at target. Second, risks are accumulating around the global growth outlook, particularly China, and liquidity risks are pertinent to global financial markets. The impacts of the RBNZ’s proposed capital changes are uncertain, but unambiguously represent a tightening in financial conditions that will need to be offset with a lower OCR. And finally, the outlook for tradable inflation is also weaker, courtesy of lower oil prices. Data this week includes key reads on both inflation and growth momentum.