Economic update: A soft landing for New Zealand?

Inflation is close to or has peaked in many of the world’s major economies, but it remains highly uncertain how quickly it will come down. Experts are now turning their attention to the duration of the downturn and associated impacts of fiscal policy management.

Inflation in New Zealand isn’t as high as in many other countries, but nor has it fallen meaningfully from its peak. It has sat around 7% for a full year. Core inflation measures in New Zealand are all above 5% and many are still rising. Domestic inflation is also running high at 6.6%. It’s what we might call ‘sticky inflation’, driven by high inflation expectations and a tight labour market.

Firms also report that scarce skilled labour is a concern at the present time. Labour market tightness has never been such a constraint on growth as it was in the second half of 2022, with staff shortages impacting trading hours and revenue-generating activities.

Wage costs increase when labour markets are tight, resulting in working capital constraints. This is particularly the case when labour costs can’t be passed to the customer.

However, staff wage costs aren’t the only factor weighing on the business community, with regulation and paperwork, and non-wage cost inflation all nominated as problems.

It’s still a long way back to the inflation target of 1-3% and it’s unclear how much the economy, particularly the labour market, needs to slow to get there.

Though both Australia and New Zealand face similar economic challenges, the two countries’ central banks have taken different approaches in their attempts to manage inflation.

The Reserve Bank of NZ (RBNZ) has increased the official cash rate (OCR) to 4.75% and it current expects that further increases will take the terminal rate to 5.5% later this year. This approach differs significantly to that taken by its Australian counterpart, which has pushed the OCR to just 3.6% and which anticipates the cash rate to level out at 3.85-4.10%. There are a couple of reasons for the difference: in particular, Australian households are more indebted, and more are on floating mortgage rates, meaning the impact of rate hikes is felt more quickly.

Although increases in New Zealand’s OCR are expected between now and May, the hikes may not be as scary as they seem in real terms (eg bearing strong wage inflation in mind), though still undoubtedly a concern for those with plenty of debt. But it is worth remembering that only a third of households even have mortgage debt.

The question is whether RBNZ’s ‘bark’ might negate the need for the bank to actually bite the economy as hard as it says it will. The November Monetary Policy Statement, with it’s mega 75bp hike and talk of a “deliberately engineered” recession certainly had an impact on both business and consumer confidence, though it seems to have dissipated somewhat since.

The ANZ’s Survey of Business Opinion (ANZBO) suggests downside risks to the RBNZ’s forecasts for business investment, housing construction and overall GDP.

It also shows business sentiment hit a record low in Q4 after a hawkish November Monetary Policy Statement (MPS).

Businesses are clearly worried about the state of demand for their goods and services. They are expected to ease back on their investment and their staff headcounts as a response. A recession could well be on the cards, but the GDP data remains very volatile due to impacts from Covid, the border reopening, and now the cyclone, so we’d downplay the importance of technical measures of recession. For most people recession is when they’re in danger of losing their job. We do expect unemployment to rise, but possibly not as quickly as the RBNZ is forecasting (i.e. immediately).

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