Weekly Economic Commentary 7 February 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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It’s raining, it’s pouring.
The heavy rainfall in Auckland and parts of the upper North Island has left many people with a major recovery job in the months ahead. While we don’t think this will meaningfully alter the outlook for the wider economy, there will be some effects to watch for in the upcoming data.
It’s still early days in terms of gauging the scale of the damage, and we’ll review our numbers as we go. Based on what has been reported so far, we estimate that it could be in the range of $500m, and potentially higher.
This makes it New Zealand’s most expensive weather-related event by quite some margin. However, it’s well short of the cost of repairs that followed the 2010-11 Canterbury earthquakes, which came in at around $40bn (spread over many years). Repairs following the 2016 Kaikoura earthquake cost around $2bn.
To put these numbers in perspective, nationwide building activity (including infrastructure) is currently running at over $50bn a year. Moreover, the industry is already stretched to capacity, especially in the residential building sector. This is a major contrast with the Canterbury earthquake rebuild, when the industry was starting from a depressed state in the wake of the GFC recession.
As a result, we suspect that flood recovery work won’t end up being much of a boost to building activity – rather, we may see some projects delayed or shelved while the repair work takes priority. The additional pressure is instead likely to be channelled into prices. There were signs that construction cost inflation was starting to slow at the end of 2022, but it may now take longer to recede.
We are also likely to see food price inflation hold up for longer. Vegetable growers were already contending with poor growing conditions that saw prices rise by 23% over 2022, and this year’s flooding has caused major damage to some crops in the Auckland region.
Both of these effects should be temporary, as the repair work is completed and as the new growing season begins. They are not a source of sustained inflation that might warrant a response from the central bank. However, they will require some patience to look through as they feed into the inflation data over the coming months.
Delayed downturn
The additional work created by the flood recovery doesn’t detract from the broader issues that the homebuilding industry faces. The level of activity remains very high for now, but the financial incentives for housing development have turned a lot less attractive. Interest rates have risen sharply, building costs are rising rapidly, and existing house prices have fallen. This is leading to hesitancy among both developers and purchasers. As a result, we expect to see building consents easing back from their current elevated levels over the next few years.
That doesn’t mean that a crash in construction activity is imminent. Indeed, over the past year, the number of new consented projects has risen much faster than actual construction activity. As a result, there still is a substantial existing pipeline of planned work. The construction sector is continuing to grapple with stretched capacity and shortages of skilled staff. Those conditions are acting as a handbrake on the pace of building activity. We expect an easing in construction activity over the next few years as fewer new projects come to market. But that is likely to be a gradual easing from high levels.
Even a gradual downturn will prove challenging for some operators. As our recent report notes, the homebuilding industry is dominated by small players, often weakly capitalised and with little oversight of their finances. Even in the best of times, construction firms account for an outsized proportion of business failures. Those that can tightly control their costs and diversify their sources of income will be best placed to ride out the downleg of the cycle.
Turning point
Last week’s employment figures for the December quarter were close to what was expected by market forecasters and the Reserve Bank, if anything fractionally on the softer side. The labour market is still very tight, but there are signs that we’ve passed the very peak.
The unemployment rate rose slightly to 3.4%. That’s still close to its recent record low of 3.2%, and it’s held around these levels for the last year and a half – as good a sign as any that the economy has effectively reached full employment. Labour shortages remain top of the list of businesses’ concerns, although the number of job vacancies has receded from its highs in recent months.
The greater story will be around what happens in the year ahead, as higher interest rates increasingly weigh on people’s spending, and in turn what that does to the demand for workers. We’re expecting the unemployment rate to rise over the next couple of years to a peak of 4.8% – not that high compared to history, but consistent with a much lower rate of wage and price inflation than we have today.
Market forecasts and pricing now seem to have converged around a 50 basis point increase in the OCR at this month’s review, reaching a peak of 5.25% within the next few months. That matches the call that we made last week after the inflation figures. We’re also seeing some of the popular one- and two-year fixed mortgage rates being trimmed, reflecting the slightly lower expected peak in the OCR for this cycle.
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