Weekly Economic Commentary 23 January 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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It’s gonna be a bumpy ride.
The new year has gotten off to a rocky start for the New Zealand economy. Signs of a downturn in both the household and business sectors are mounting. And with a significant tightening in financial conditions over the past year, we expect that economic activity will continue to weaken over 2023. Despite that, we’re yet to see signs that inflation pressures are easing.
Looking first at the household sector, nominal spending levels slumped in December, dropping 2.5%. Spending was down in nearly all categories, with sizeable declines in discretionary areas, like durables and apparel. That’s particularly notable as for most of the past year, households were continuing to dial up their discretionary spending levels despite some large price increases.
As we’ve been highlighting for some time, households’ finances are coming under increasing pressure on several big fronts. First is the sharp rise in consumer prices that has been eating away at households’ spending power. The past year has seen particularly large increases in the prices of necessities. Notably, housing and accommodation costs were up 9% in the year to September, and food price inflation hit a 32 year high of 11% in the year to December. Those increases are being felt by every family across the country. They’ve been particularly tough on those families on lower incomes, who tend to spend a larger share of their earnings on necessities.
Compounding the pressure on households’ finances has been the sharp rise in mortgage interest rates over the past year. Thus far, many households have been insulated from the march higher in mortgage rates. That’s because around 90% of New Zealand mortgages are on fixed rates, and many borrowers are still on the very low rates that were on offer in the early stages of the pandemic.
However, as discussed in our recent report “From squeeze to crush” a dramatic increase in borrowing costs is set to hit many New Zealand households through 2023. Around half of all loans will come up for refixing over 2023. Many borrowers will be faced with significant increases in debt servicing costs. In some cases, borrowers could see their mortgage rates rising by more than 3 percentage points. That will offset much of the boost from the strong labour market and accrued savings.
As the full brunt of interest rate increases ripples through the economy, household spending is set to slow sharply and we expect that the economy will slip into a shallow recession in late 2023/early 2024. And as activity weakens, we’re also likely to see unemployment trending higher, rising from 3.3% currently up to 4.8% over the next few years. For the affected households, that will further compound the pressure on their finances.
Adding to the downwards pressure on household demand, the housing market has continued to slow. Prices fell by another 1.3% in December and are now down 15% since their peak in 2021. We’ve also seen sales dropping to lows that we last saw during the global financial crisis. New Zealanders hold a large amount of their wealth in owner occupied or investor housing. Consequently, the fall in prices now in train represents a sizeable knock to many households’ net worth.
The downturn in demand is already being felt in the business sector. The past three months saw a sharp fall in trading activity, with a net 13% of businesses in the latest Survey of Business Opinion reporting weaker trading activity in the December quarter. The majority of businesses expect activity will continue to weaken over the early part of 2023, with businesses scaling back their plans for hiring and capital expenditure.
But while the economy may be turning down, that’s after an extended period where it’s been running hot. For now, the economy remains stretched. Crucially, we’re not seeing any signs that inflation pressures are easing. In fact, recent months have seen increasing numbers of businesses reporting that operating costs have increased. At the same time, there has also been a lift in the number of businesses who have been raising their output prices.
We expect that those ongoing pressures will be reflected in this week’s inflation report. We estimate that consumer prices rose by 1.1% in the three months to December. That would see the annual inflation rate slipping to 6.9%, down from 7.2% in the year to September. But even with the annual inflation rate starting to soften, prices are still rising at an alarming pace, with annual inflation remaining close to multi-decade highs.
As always, the devil will be in the detail. The December quarter saw big swings in some specific prices. That includes large supply driven increases in food prices and a continued post-pandemic rise in air fares, as well as a sharp 8% drop in fuel prices. But looking at the underlying trend in prices, most measures of core inflation have been tracking above 6%, and we expect that they will have remained around those levels in the December quarter. Looking ahead, we don’t expect that inflation will be back within the RBNZ’s target band until mid-2024. That will keep the pressure on the RBNZ to continue hiking the cash rate for some time yet.
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