STATE OF THE NATION - SHARON ZOLLNER, ECONOMIC COMMENTARY
The New Zealand business cycle continues to age fairly gracefully. We’re seeing some classic signs that “the top” for growth is in – firms can’t find staff, confidence has topped out (though remains solid), and retail interest rates are rising. However, this is not to say that the good times are at an end, just that the low-hanging fruit may have been picked, and further growth will be harder won from here.
The construction sector is where capacity constraints are most apparent. Around the country residential, commercial and infrastructure construction are going great guns, leading to significant cost inflation. Although Auckland in particular has a significant shortage of housing, we believe the rapid growth in the construction effort is due to taper as the industry struggles with both a lack of staff, and increasingly wary lenders who are rationing credit in response to a mismatch between very strong demand for credit and lacklustre deposit growth.
The Auckland housing market has cooled markedly despite ongoing strong population growth. Turnover is down around a third on a year ago, and prices are lower than a few months ago. However, given ongoing very strong net migration and still-low mortgage rates, a risk of the market re-igniting remains, despite very stretched affordability. The Reserve Bank therefore appears to remain wary of prematurely declaring victory.
The same can be said of the Reserve Bank with respect to deflation risks. Although Consumer Price Index (CPI) inflation has ticked back up to the midpoint of the target band, this has been driven primarily by temporary factors such as lifts in food and fuel prices, with most measures of core inflation remaining subdued. The Bank remains in no hurry to hike the Official Cash Rate as it is forecasting inflation to peter out again.
While we certainly consider that a valid view, we suspect that the fact real wages are now falling, combined with severe labour shortages, excellent profitability across much of the economy, and the recent settlement between the Government and aged care workers that could reset wage expectations across much of the unskilled labour sector, mean this inflation upswing might have more grunt than previous short-lived lifts. Time will tell.
Traditional late-cycle structural imbalances have not emerged to the extent they have in previous cycles: the current account and net foreign debt are contained. This is encouraging. However, extremely stretched housing affordability and record-high household debt as a proportion of income are red flags that have caught the attention of both regulators and rating agencies. Should things take a turn for the worse due to a negative global shock, for example (such a shock has traditionally provided the coup de grace for New Zealand’s economic expansions) then high household debt means consumption will fall into a deeper hole than otherwise. Taking on debt is bringing forward spending from the future, and that future tends to arrive all in a rush during recessions.
But that remains a story for another day – hopefully one well down the track. For now, confidence is robust and the labour market is strong around the country. Tourism is booming, migration remains strong, the construction sector is going all out, and global dairy prices have dug themselves out of the hole. A degree of caution is warranted, given elevated global risks, but all going well the good times can roll on for a significant period yet.
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