STATE OF THE NATION – DECEMBER 2020
Economic Update from Sharon Zollner – ANZ Chief Economist
COVID-19 continues to wreak havoc around the world, with cases rising sharply in the Northern Hemisphere, necessitating renewed restrictions on peoples’ movements and interactions to prevent health systems from being overwhelmed. There is light at the end of the tunnel, with excellent news on the vaccine front. But stringent safety requirements and manufacturing and distribution hurdles mean it won’t mean a light-switch end, and there are near-term challenges to get through in the meantime. For now, global markets are focused on the positives, and both monetary and fiscal policy has been highly effective in seeing activity rebound. Particularly in countries, such as New Zealand, where virus risks have been well contained.
New Zealand’s elimination strategy is going well, with the odds of an Alert Level 4 lockdown much reduced, though not zero. Business sentiment has bounced back. The generous and rapid wage subsidy scheme filled the income hole from the lockdown, and low interest rates have put a fire under the housing market. Markets and economists are becoming less certain that a negative OCR will be deemed necessary. But the income lost from the closed border hasn’t really been felt yet; we haven’t actually had the recession, rather just a massive temporary disruption to activity.
How bad it will be, and when it will hit, are both very uncertain. We certainly have a lot more momentum than anyone dared hope at the moment. But the fact remains that we estimate the closed border knocks out about 5% of the economy. With the flow-on to retail and hospitality making it worse, and the fact Kiwis can’t flee for warmer climates in winter providing an offset. And unfortunately, the sectors most impacted by this shock are the people-centric ones: tourism, hospitality, and retail. The hit to employment will be correspondingly larger than it would be if the shock to GDP were a drought affecting agriculture production, for example. But so far, the lift in the unemployment rate has been smaller and later than originally feared, with no immediate spike once the wage subsidy expired. Tourism firms were sitting on cash after a good summer, got another solid dollop from the wage subsidy, and then enjoyed a better-than-expected winter, as New Zealand typically exports more tourists to warm climates than it imports skiers through those winter months.
But come summer, the numbers flip, and viciously. The big hope is a travel bubble. But the Government is taking an understandably cautious approach to gambling the fate of 95% of the economy to help out the severely hurting 5%. A travel bubble would have relatively modest impacts at a GDP level, as Kiwis would no doubt rush overseas, but it would save some jobs. But if it went wrong, it could be catastrophic.
For now, businesses are feeling pretty good about life. The fact that higher-earning households have been little affected, mortgage payments went on hold for 7% of households, freeing up cashflow, the “Provence 2020” bank account went on a spa, and a “carpe diem” vibe pervades the economy, business is booming for many. But it’s reasonable to question the sustainability of aspects of the spending. Once the holiday budget is gone, it’s gone. The second round of the mortgage deferment scheme is far harder to qualify for. The catch-up spending from lockdown must have nearly run its course. The $1bn that was knocked off credit card balances in the first lockdown will have been either saved or spent by now. And stock shortages are emerging in all kinds of areas as COVID plays havoc with transport logistics.
Adding a petering out of retail momentum to the delayed border impacts, we see the economy stalling somewhat in the first half of next year. That could reasonably be interpreted as the recession finally arriving, in terms of a slowdown that reflects people’s choices, as opposed to government health policy choices. We therefore expect that the Reserve Bank will indeed deem more stimulus necessary, despite the booming housing market.
In the November MPS, the RBNZ revised up their forecasts, while stressing the medium-term challenges and reiterating that they stood ready to deliver more stimulus if required. The market focused on the forecast upgrade, and all but priced out any chance of a negative OCR. But in our minds, it remains a very real possibility. The RBNZ estimates that a further 70-80bp of easing is required, and with the Large-Scale Asset Purchases (LSAP) quantitative easing programme ticking along in the background, and the bank funding for lending programme perhaps worth another 20-40bp, it’s not clear that the RBNZ is going to be able to deliver the amount of stimulus they deem required without cutting the OCR further. But the urgency is certainly much reduced. On balance, we are now expecting a cut to a low, but positive rate (e.g. 0.1%) in May, and then we are just over the line for predicting a further cut to -0.25% in August. But it’s looking highly conditional and uncertain, and we’d be delighted if it didn’t happen both because we are no fans of negative rates, and because it would mean that things are going well.
The housing market has surprised everyone, with the combination of record-low mortgage rates (and expectations that they’ll stay low for a long time, if not go lower still), and the suspension of LVR restrictions seeing house prices boom all over the country. Everything is obvious in hindsight, but it’s just worth noting that in 2008, the RBNZ cut the OCR by almost 600bp, and house prices fell 10%. A similar kind of track was anticipated this year, but instead, house prices are up by around that amount. As a result, the RBNZ will be bringing back LVR restrictions earlier than initially envisaged, while ploughing ahead with a bank funding scheme designed to lower retail interest rates that will add a lot more fuel to the housing market than it will to business investment in the near term at least, given firms are still in a cautious mood as regards borrowing and investing. It’s certainly a case of push-me-pull-you, as the Reserve Bank attempts to balance its inflation targeting and financial stability objectives.
Improved housing sentiment will certainly have contributed to the robustness seen in spending this year. But with national income taking a big hit, housing resilience does have unfortunate implications for housing affordability, wealth inequality, and the risks of a boom-bust cycle should the economy sour. We expect house prices and household debt to remain hot political topics for some time yet.
Debt of all kinds has exploded since 2008 globally, and the COVID pandemic has turbocharged it, as interest rates go lower yet, and fiscal policy ramps up to fill the income hole left by repeated lockdowns. One does wonder about the end-game. What will happen when inflation pressures rise, and central banks have to choose between being inflation ‘targeters’ or being fiscal policy enablers? But for now, the two look the same, and fiscal prudence is seriously out of style. Here in New Zealand, government debt is forecast to peak a bit over 50% of GDP – a level lower than many countries had going into this crisis. And corporate balance sheets are also very robust. So despite record-high (and rising) household debt, we’re in pretty good structural shape overall. But if interest rates here remain as low for as long as is generally expected, the recent history of other countries suggests that that will change. At some point, debt will once more be considered a risky thing to have, and printing money without limit will be seen as a risky thing to do. But for now, it’s game on.
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