Weekly Economic Commentary 1 May 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Waiting for the turn.
With inflation now clearly past its highs, it looks likely that the May policy decision will mark the peak in the Reserve Bank’s tightening cycle. But there are still a few things coming up in the weeks ahead that could keep the RBNZ on guard.
First up are the labour market surveys for the March quarter, which will be released on Wednesday. We expect the unemployment rate to hold steady at 3.4%, not quite at the record lows seen last year, but close to it. The labour market remains tight, with labour shortages still one of businesses’ top concerns.
The monthly indicator of filled jobs shows that employment has been growing at a fairly steady pace over the last year, and if anything has picked up momentum in the last few months. That will be, at least in part, because there are more people around to hire. Since New Zealand reopened its border last year, net migration has rapidly switched from a modest net outflow to a strong net inflow. The bottom line, though, is that businesses are still firmly in hiring mode.
The RBNZ has emphasised that bringing inflation under control will most likely require engineering a recession, with a corresponding rise in unemployment. However, in its February Monetary Policy Statement forecasts, that didn’t really come into play until the June quarter and beyond. For the March quarter, the RBNZ was expecting just a slight uptick in unemployment to 3.5%.
Hence, a flat outturn in line with our forecast probably wouldn’t move the dial in terms of the May policy decision; we expect a further 25 basis point hike to 5.50%. But for the RBNZ to be satisfied that that’s enough, it’s going to need to see some evidence pretty soon that the labour market is losing steam.
What’s more, the resurgence of workers from overseas will itself be on the RBNZ’s radar. The RBNZ has typically regarded migration as a source of net demand, adding to inflation pressures. And migration has bounced back a lot faster and stronger than the RBNZ expected, enough to warrant a mention in the April OCR review. While we don’t share that view – migrants add to both demand and supply, with the net impact on inflation unclear – it is nevertheless the RBNZ’s interpretation that will play a role in upcoming policy reviews.
Wage growth is likely to have remained strong in the March quarter. That’s largely because it tends to be the most lagging element of the economic cycle – we didn’t really see it start to take off until early 2022, long after inflation had surged and the RBNZ had started raising interest rates. In a similar vein, we expect the Labour Cost Index (LCI) to accelerate to an annual pace of 4.4% this quarter, even with consumer price inflation now clearly past its peak.
The LCI is based on pay rates by role, rather than by worker. To get a better sense of what workers are actually getting in hand, we can look at the Quarterly Employment Survey (QES) measure of average hourly earnings, which captures the effects of people changing jobs or even industries in order to get a pay rise. While this measure is much choppier than the LCI from quarter to quarter, it shows that pay growth rose above 7% last year, broadly matching the rate of inflation. That demonstrates the challenge the RBNZ faces: inflation has now got into wages. Once that happens, it can be a long and painful process to remove it again.
The other key event ahead of the May Monetary Policy Statement is the Budget on 18 May. One of the big items in the Budget will be the cost of rebuilding after the flooding in late January and Cyclone Gabrielle in early February. Last week the Treasury estimated that the total cost of rebuilding could be between $9bn and $14.5bn, easily making it the second most expensive natural disaster in New Zealand’s history (after the Christchurch earthquake).
A large share of that cost will be borne by the Government, reflecting the nature of much of the damage such as roads, bridges and water infrastructure. In a speech last week, Prime Minister Hipkins indicated that this will not be funded through new sources of revenue, but from a mix of additional borrowing and reprioritisation of existing spending plans.
The RBNZ has raised the cyclone recovery as an upside risk for inflation, as it will create an additional draw on the nation’s resources over several years. Whether it does prove to be a significant inflationary force is up for debate, however. Infrastructure tends to be one of the less inflationary forms of government spending, and the fact that it will be partly funded from within the existing budget will reduce the net impact. Moreover, the experience of the Christchurch earthquake was that although construction costs did pick up substantially when the rebuild began, this didn’t translate into a lift in inflation more generally.
Nevertheless, these perceived upside risks to inflation will keep the RBNZ on high alert, until it sees convincing evidence that the economy is cooling down and that inflation is coming under control. In that regard, market expectations for OCR cuts to begin by the end of this year are likely to be disappointed.
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