The New Zealand economy is cooling, as the lagged impact of the Reserve Bank’s aggressive tightening cycle works its way through the economy. In particular, discretionary spending has taken a big hit and the outlook for residential construction is much weaker. We are forecasting a mild recession and higher unemployment in the second half of the year. There are also downside risks that have nothing to do with monetary policy: China’s slowdown is seeing New Zealand’s export prices drop sharply, particularly dairy prices, in a development that will wipe out billions of dollars of exporter income.
At the same time, however, there are offsets, and it is not clear that the economy is capitulating as rapidly as the Reserve Bank expects – or rather, requires.
Fiscal policy is still very stimulatory. Compared to the Half-Year Update at the end of 2022, the Government is injecting an extra 1.4% of GDP into the economy in the 12 months to June 2024. The jury remains out on whether spare capacity is opening up quickly enough to make space for this spending without an intensification of inflation pressure.
Net migration is another wild card. Arrivals soared early in the year once the border was finally reopened and immigration rules were significantly relaxed. More recently, monthly arrivals have dropped away while departures have lifted, seeing the net number fall quickly. But still, estimates of net migration for the year have been revised up substantially. On the one hand, this is easing labour shortages quickly – firms are reporting that it is now much easier to find labour, and that availability of labour is no longer the primary constraint on their expansion. But new arrivals also need somewhere to live, and other goods and services. We are already seeing some upward pressure on rents, and population growth has likely also contributed to house prices finding a floor in recent months. The net impact of migration on inflation pressures is ambiguous, and is another one to add to the “wait and see” pile.
The RBNZ remains optimistic that it has done enough in raising the Official Cash Rate (OCR) to 5.5% – a lift of over 500bp in less than two years. Indeed, it has done a lot! But with the OCR still below the rate of inflation, whereas it took an OCR of 8.25% to get on top of CPI inflation of 5% in the early 2000s, the peak in the OCR must necessarily remain subject to a degree of conjecture until inflation is well on the way back into the target band. In its August Monetary Policy Statement, the Reserve Bank revised up its forecast track for the OCR by 9bps – falling well short of a threat to raise rates further, but a hat tip that is how it is seeing the balance of risks currently.
There is some low-hanging fruit in terms of getting goods inflation down. Large prices from more than a year ago dropping out of the annual calculation are a free head start. The global oil price nearly halved from its peaks – though it’s starting to creep higher again. Global shipping costs have dropped like a stone. The RBNZ can’t take any credit for any of the global disinflation, but they’ll welcome it with open arms. Barring a further energy shock, it should be fairly straightforward to get inflation down from its peak of over 7% to around 4-5%. But our suspicion is that getting ‘core’ and non-tradable inflation back where it needs to be to finish the job will prove harder. Gravity won’t do it – a chunky rise in unemployment is probably unfortunately required.
And on that front, it doesn’t appear that households have gotten the memo that their job security is under threat. Surveys suggest that perceived job security remains very high – though perceived job availability is certainly showing cracks, as are job ads, and the number of applicants per job ad has risen enormously. But for now at least, wage growth remains strong – real wage growth has been positive. While we do expect unemployment to rise in the second half of the year, labour demand for now is proving fairly resilient – the loosening in the labour market has so far been more of a rising labour supply story. Business and consumer confidence, while subdued, are both well off their December lows. Overall, we suspect the RBNZ will need to do a bit more work, and see a modest tightening resuming by the end of the year, assuming no global side swipe (which, it’s worth noting, in practice tends to be how New Zealand’s business cycles end).
Recent years have certainly demonstrated why any macroeconomic forecaster needs to be modest about the odds that their view is correct.
Reasons why the OCR might need to go higher than the 5.75% we are forecasting include sticky inflation, more robust labour markets than anticipated, a more vigorous housing rebound than we expect, the NZD falling out of bed spectacularly, or a global energy shock.
Reasons why the OCR may in fact be cut earlier than the late-2024 timeframe we envisage fall mostly (though not exclusively) into the category of “be careful what you wish for”: a more serious hit to export revenue, a global financial markets shock affecting bank funding costs, labour demand dropping away more rapidly than anticipated, or more positively, inflation proving less sticky than expected.
Times remain uncertain, and the plan and expectation that central banks will get on top of the highest inflation in decades without breaking anything is a best-case scenario. But if the seas do get rougher, New Zealand is in a relatively good position. Household debt relative to incomes is lower than it peaked in the last business cycle. House prices relative to incomes are back where they were pre-COVID, with very little damage done from the near-17% fall. Businesses, overall, are not highly indebted, despite the easy availability of cheap credit during the COVID period. Government debt, while far larger than it was, is still low in a global comparison. The banking system is extremely well capitalised, and has stuck to its knitting. There’s a hangover from the COVID period, certainly, but financial structural metrics remain sound. New Zealand’s large current account deficit is a black mark next to our name, however, and ultimately reflects that we have been living beyond our means for some years. At the end of the day, that’s why we’re going to have a recession, not because the RBNZ Monetary Policy Committee thinks we should.