Weekly Economic Commentary 11 March 2024
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Fiscal pressures and construction crunch
This week’s data on the tax take and construction highlighted the economy’s weak momentum. In addition, a pullback in dairy prices after a strong run illustrates the ongoing downside risks to global demand.
First up, the Treasury’s latest update highlighted the weakness of the economy and ongoing pressure on the fiscal purse strings. Tax revenue for the seven months to January was $800m below forecast. Corporate tax and taxes paid by the self-employed were down $500m and $300m respectively due to weak profits, while GST was down $200m due to weaker consumption spending. These falls were partially offset by a lift in PAYE tax, reflecting the resilience in the labour market. At this stage, fiscal expenditure is also running behind forecast, so the Government’s operating balance remains close to the half-year economic forecasts (for now).
We’ll be watching the Treasury’s next few updates to see if January’s outcome was the start of a trend. The Government is aiming to get the operating balance back into surplus in the 2026/2027 fiscal year. But with economic activity still weak and ongoing pressures on spending reflecting population growth and cost pressures, the Minister of Finance has indicated that achieving this will be challenging. We agree.
Next, the latest GlobalDairyTrade auction saw total prices falling 2.3% with the key whole milk powder (WMP) price down 2.8%. This was the first fall in overall dairy prices since November 2023 and the second decline in WMP prices in a row. We are still happy with our forecast for a $7.90 payout this season and a $8.40 payout next season. The outlook for the current season is fairly locked in at this late stage of the season, but next year’s milk price will be importantly determined by prices in coming months and will especially be influenced by the performance of Chinese consumer spending which still looks weak.
Lastly, the latest building work survey showed that construction activity remained steady through the December quarter, with building activity easing just 0.1%. But while that resilience is encouraging, under the surface there are clear signs of softness, and we expect activity to turn down over 2024.
Much of the resilience in construction activity over the December quarter was due to a 4.6% rise in non-residential construction. However, work on non-residential projects can be ‘lumpy’ on a quarter-to-quarter basis, and December’s rise followed a similar decline in September. Taking a longer-term perspective, non-residential construction activity has flattened off over the past year. In addition, with economic conditions softening, fewer new projects are coming to market, with the amount of floor space consented over the past year down 12.5%.
On the residential front, building levels were down 2.4% in the December quarter, and they’ve fallen 9% over the past year. Over the coming year, we’re forecasting a further 10% decline in residential building which will be the sharpest slowdown since the Global Financial Crisis when residential construction activity fell by 30%.
Tougher financial conditions in the building sector, high materials costs and crucially the weaker housing market since the 2021 peak is driving the decline in construction we see today. Developers remain reluctant to bring new projects to market and hence new dwelling consents have fallen nearly 30% over the past year. We also expect that a higher-than-usual proportion of planned projects will be cancelled.
We don’t expect that actual home building will fall as sharply as consent issuance. That’s because earlier shortages of materials and staff, as well as stretched capacity more generally, acted as a brake on how much work could be completed in recent years. As a result, although consent issuance rocketed higher in recent years, building activity rose more modestly. Although forward orders are now declining, many firms are still working through existing pipelines of planned work. Even so, New Zealand is still likely to see a sizeable slowdown in home building activity over the next few years.
That slowdown in building is occurring at the same time as population growth is booming. Over the past year, New Zealand’s population grew by a massive 145,000 people implying a need for around 55,000 additional houses. However, we estimate that the number of homes in New Zealand only increased by around 30,000 over the last year.
We expect population growth will slow over the coming year. Even so, New Zealand is going to need a lot more houses. On top of the existing housing shortfall, we’ll need to build around 110,000 new homes over the next five years to keep up with population growth.
The past few years have shown that we can achieve the necessary pace in home building activity. However, with net migration still running at near record levels for now and home building turning down, many parts of the country are likely to face ongoing pressure on housing supply for some time yet. In addition, with an extended period of rapid home building needed to address supply shortages, we’re likely to see continued pressure on build costs.
Finally, we learned late in the week that the Government is moving ahead with reinstating the tax deductibility of mortgage interest for residential property investors from April 1, 2024. Both new and existing investors will be able to deduct up to 80% of interest costs in the upcoming tax year and 100% thereafter. This will improve the fortunes of property investors and will help encourage them back into a market they have been largely absent from for some time. We see house prices remaining fairly flat for the immediate future given slow sales volumes and auction clearance rates but a pickup later in the year as population growth pressures (and perhaps the expectation of future interest rate cuts) assert themselves.
The economic data flow will pick-up over the coming week. First up is the February update on the housing market from REINZ, which is likely to show that housing market turnover has remained subdued in the face of high interest rates. Similarly, February’s update on retail card spending (out Tuesday) is expected to again highlight weakness in spending appetites with financial pressures continuing to squeeze households’ budgets. On Wednesday we’ll get Stats NZ’s monthly price indicators for February, which will be a key focus for the RBNZ. Lastly, we’ll be watching Thursday’s update on net migration to see if the recent rise in departures has continued.
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