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PartnersJune 20, 2023

Inflation, migration and the cyclone rebuild: an expert take on the economy

an orange background with a line going down and a fist with some cash in it
(Image: Getty; additional design: Tina Tiller)

With interest rates steadily rising over the last 19 months, it seems we have finally reached the peak. So what does this mean for households, businesses and the cyclone rebuild? Kiwibank chief economist Jarrod Kerr weighs in.

At a glance:

  • We have reached the peak. According to the RBNZ, they are done hiking, having lifted the cash rate from just 0.25% in 2021, to 5.5% today. The next move should be a rate cut, early in 2024.
  • A lot has changed in the last 9 months. The economy has softened. It’s an awkward period for households, rolling onto higher interest rates, and businesses face new challenges. But it’s not all doom and gloom. 
  • Net migration has exploded. And we expect to see some green shoots in the housing market.

The cost of living crisis means our incomes are not keeping up with inflation; we’re getting a lot less for our money. Add onto that a surge in interest rates and many households and businesses are hurting.

Households and businesses with debt are now paying a much larger proportion of their income on interest. Household budgets are being stretched thin and businesses are reducing their investment and hiring. Confidence among households and businesses has also been hit by the fall in house prices. 

The good news is interest rates may have peaked. Since October 2021, the Reserve Bank of New Zealand has been hell-bent on dragging inflation back down to 2%. They have yet to achieve this, with the current rate at 6.7%, but they think they have done enough. That’s an important message for Kiwi households and businesses. We have likely seen the peak in lending rates, and as with all peaks, we will come down the other side. Tailwinds are coming.

Kiwibank chief economist Jarrod Kerr (Photo: Supplied)

For every upside risk, there are three downside risks

The RBNZ is forecasting the cash rate to remain on hold at 5.5% well into 2024. There are risks to both sides of this forecast. If the upside risks come through, the RBNZ may be brought back into the fray, and forced to hike again. Then there are the downside risks. We expect to see rate cuts sooner than forecast by most commentators and the RBNZ. 

“…higher net immigration, a slower decline in house prices and higher government spending are offset by the lower starting point level of GDP and consumer price inflation as well as a more negative outlook for our goods exports.” (RBNZ MPS, May 2023)

The upside risks to migration and government spending have engulfed the airwaves, with many commentators calling for more hikes. We disagree.

We have seen an outsized +65,000 in net migration over the last year – that’s a lot of people coming here looking for work. The surge surpassed our optimistic forecast of +35,000. But most of the spike in migration was pent-up demand. Migrants who would have come here over the last few years, but couldn’t due to border restrictions, are coming now. We think migrant flows will naturally fall back, and so does the RBNZ. “The big surge in immigration is behind us,” says RBNZ governor Adrian Orr. 

Faster population growth increases demand for just about everything. Migrants take rentals or buy houses, putting upward pressure on rents and house prices. They also put greater demand on our infrastructure, health system and education, because more people equals more demand. But they are also coming at a time of chronic staff shortages across most industries. Most migrants are aged between 20 and 40 and keen to work. Migrants boost the capacity of the labour force and put downward pressure on wages. The RBNZ has taken the view that the migrant boom will be less inflationary than many fear.

The cyclone rebuild and government spending will be inflationary, but maybe not as much as many fear. It is difficult to gauge how inflationary the rebuild will be. But at this stage, it is likely to be less than initially thought. Fears of government spending may be exaggerated and it is also likely that there is continued underspend. The government may continue to struggle to get funds out the door fast enough. The economy is weaker, and government spending may hit at a time of reduced aggregate demand. 

There are more risks to the downside. Government tax revenues have come in well below forecast, with both GST and corporate tax undershooting. The downshift in the government’s coffers confirms the downshift in spending on Kiwibank credit and debit cards. Household consumption looks to be contracting. And confidence among businesses and households has soured. 

Demand is being weighed down by rising interest rates.

If households spend less, which is what we are seeing, then the economy will contract harder. If businesses pull back on their hiring and investment, which is what we’re hearing, then the economy will contract harder. If these downside risks dominate, then interest rate cuts will come sooner. 

Kiwibank’s new branding (Photo: supplied).

It’s all about inflation

Imported inflation is easing, but it’s homegrown inflation that concerns the RBNZ. Inflation is only forecast to fall below 3% late in 2024. It’s still a long journey back to the 2% target. The good news is, we’re on the way. 

The forecast slowdown will drive a loosening in the labour market. Add to that the migrant-led increase in labour supply, at a time when demand is turning south. We may see the unemployment rate rising to between 5% and 5.5% in 2024. As the labour market loosens, its inflationary impulse will soften. 

The NZ housing market will bottom, soon

There are three drivers of the housing market. Firstly, the peak in interest rates should mark the bottom in the housing market correction. Falling mortgage rates should support confidence and activity in the warmer months. The dominant headwind will soon become a tailwind. Secondly, the demand/supply imbalance will worsen. The surge in migration and the loss of dwellings at high risk of climate change will only exacerbate the housing shortage. 

Finally, the residential construction boom is turning south. The number of dwellings coming to market will fall back from very high levels. Supply had outstripped demand in recent years – with record high dwelling completions and low population growth (prior to the migration rebound). All three drivers point to a strengthening housing market.

The true litmus test for the market will be in spring, when we expect to see an uplift in confidence and activity. 

The New Zealand dollar will help exporters (Image: Getty)

The dollar will help exporters, not importers

The New Zealand currency has lost a lot of ground following the RBNZ’s peak rates announcement. If this is the peak in the OCR, and we think it is, we expect to see further falls in the dollar from here. Our long-held forecast is for 0.55c by year end. Softer export prices, weakening growth, and compliant inflation, means lower interest rates, and narrowing interest rate differentials. 

The fall towards 55c will help offset weakening commodity prices for exporters.  Unfortunately, a weaker New Zealand dollar makes imported goods more expensive. We have factored in the softer dollar and still expect to see a sharp deceleration in imported inflation. 

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