The New Zealand economy is at an interesting juncture. Some of the key drivers of growth over recent years are running out of puff, with the housing market, the construction sector and net migration two that spring to mind. Fortunately, other drivers are set to leap into action, namely record-high terms of trade, and – perhaps not surprisingly in an election year – fiscal policy.
The housing market is clearly slowing. Sales are down in almost all regions, price growth is coming off or appears about do so. Indeed, in Auckland, house prices are outright falling. There are a number of reasons for this: Reserve Bank LVR restrictions shutting out some would-be investors, reduced bank appetite for property risk, reduced participation by foreigners, and simple gravity, given extremely stretched affordability in some markets. The unknown is how much of the activity slowdown is due to people holding off until the election is out of the way. Certainly the Reserve Bank is wary of declaring victory too soon. However, we suspect the goose is well cooked.
The construction sector is hitting capacity constraints. Consents data for both residential and non-residential projects have been disappointing lately, as rising costs and reduced funding availability make some projects uneconomic or simply unfeasible. However, levels of construction are very high. The sector has limited ability to scale up from here, but it will remain an import source of activity and employment for years to come, with major infrastructure projects on the go in response to strong population growth.
That population growth is now easing, given flat arrivals and a gradual increase in departures (driven by non-Australasian passports). Given net migration has become a political football, it seems likely the door will be given a nudge – and it won’t be towards wider.
Given the cooling in these growth tailwinds, a lift in New Zealand’s terms of trade to near record highs is very well timed. And most encouragingly, it has been across a range of commodities, not a simple dairy boom. This bodes well for sustainability (of all kinds). As always, of course, what goes up can come down again, and we remain vulnerable to turns in the global economic cycle. But at current levels, high export prices and low import prices (particularly for oil) are making NZ.Inc unambiguously better off.
Where does this leave the Reserve Bank? Firmly on hold, we suspect. There is very little inflation to be seen, despite high capacity utilisation and a tight labour market. The reasons for this aren’t entirely clear, but it’s a global phenomenon and seems likely to persist. Headline inflation is set to dip back under the target midpoint, and measures of core inflation remain subdued. We have pencilled in a hike late next year but it’s in a 6B pencil.
Traditionally at this stage of the economic cycle (we are nearly a decade in!) structural imbalances emerge due to short memories. This time round, the current account and net foreign debt are contained – consumers have not gone on a bender. This is encouraging, as it makes the economy less vulnerable to negative shocks than otherwise. 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. And there is a good reason. Taking on debt is bringing forward spending from the future, and that future tends to arrive in a lump called a recession.
However, for now, the economy continues to do well. Transitions between growth drivers can be bumpy, and we have a closely fought election on our hands to add an extra layer of uncertainty. We may well see a few ups and downs in the growth track over the next year or so. But if the global economy keeps it together (not a trivial assumption) the good times can roll for some time yet.