Weekly Economic Commentary 29 April 2024
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Squeeze on household finances continues
The pressure on household finances remains significant. Although the Official Cash Rate has remained on hold, borrowers continue to roll on to higher interest rates. And while inflation is dropping back, we’re still seeing large increases in prices, especially for necessities like housing. A key issue for households in the year ahead is that the heat is now coming out of the labour market. Employment growth has already slowed, and the coming year will see higher unemployment along with a downturn in wage growth. There will certainly be tough conditions for many families over the coming year, with household spending likely to be weak. However, for the economy overall the downturn is likely to be manageable, with debt levels remaining serviceable.
The latest update on New Zealand households’ finances showed that, while the growth in debt levels has slowed, the average household is now carrying around 15% more debt than they did prior to the pandemic. However, while debt levels have increased in absolute terms in recent years, so did households’ ability to service that debt. The low interest rates in recent years saw the share of household incomes being spent on debt servicing costs falling to low levels. At the same time, low interest rates also fuelled rapid GDP growth, along with strong growth in employment levels and earnings. Average disposable incomes have risen 18% since 2020. As a result, the level of household-debt-to-disposable-income has fallen from 173% in 2022 to 166% now. That’s the lowest it’s been since 2015. It’s also well below the levels we saw during the 2008/09 financial crisis when many New Zealand households and businesses faced significant financial stress as economic activity turned down.
As interest rates have pushed higher since 2021, economic growth has stalled and the pressure on households’ finances has mounted. Accounting for when households fixed their mortgages, the average mortgage rate that households are paying has already risen from a low of 3.2% in 2022 to 6% now.
Even though we don’t expect any further OCR hikes from the RBNZ in the current cycle, there is still some modest further tightening in financial conditions to come as borrowers continued to roll off earlier low fixed rates. Those increases in borrowing costs will be much more modest than the very large increases that we saw over the past year, with the average mortgage rate expected to climb by a further 30 basis points over the next 12 months (around 90% of all mortgages in New Zealand are fixed for a period, and close to two-thirds will come up for repricing over the coming year).
Recent years have also seen large increases in living costs more generally, with the Consumers Price Index rising by 20% since the start of 2020. That’s eroded all households purchasing power. It’s been particularly tough for those households on lower incomes as much of the rise in living costs relates to necessities, like housing rents (up 17% since 2020), food (up 23%) and utilities/property services (up 18%).
Key to how those tougher financial conditions will affect the economy more generally will be the strength of the labour market. At this stage, the labour market remains in good health, with unemployment still very low at just 4%.
However, the heat is coming out of the jobs market, with employment growth slowing below the rate of population growth in recent months. In our recent discussions with businesses across the country, many reported that they have scaled back their plans for hiring, and some have been shedding staff. Against that backdrop and with GDP growth set to remain moribund over the coming year, we expect this week’s labour market figures will show that unemployment has already risen to 4.2% in the early part of 2024. Furthermore, we expect that unemployment will rise to around 5% by the end of this year.
As the jobs market slows, wage growth is also likely to drop back. Consistent with that, businesses are already reporting some easing in wage pressures, along with a fall in staff turnover as workers have become increasingly concerned about job security.
With still strong financial pressures and a downturn in the labour market, many households have already put the brakes on their spending. In per capita terms, nominal spending levels have been flat for a year now. And adjusting for price changes, the amount of goods that New Zealand households have been taking home fell by 3% over the past year. With the labour market to weaken further, and consumers sentiment also likely to remain subdued, we expect continued weakness in household spending over the coming year, underpinning our forecasts for weak GDP growth over 2024.
While the coming year will be challenging for many families, the downturn is likely to be manageable for the overall economy. The slowdown currently in train follows rapid growth in the wake of the pandemic that saw the economy becoming increasingly stretched, resulting in intense inflation pressures. We’re now moving back into a position of better balance. Looking at the jobs market specifically, the expected rise in unemployment is from a very low level and it is expected to be a relatively modest slowdown compared to previous downturns (for instance, in the wake of the Global Financial Crisis unemployment peaked at 6.7%).
Crucially, the increase in households’ debt servicing burden looks likely to remain manageable, even with the expected weakening in the labour market. While some borrowers have faced large increases in interest costs, the rise in the average mortgage rate has been from record low levels. As a share of households’ disposable incomes, debt servicing costs are returning to around their pre-pandemic averages. In addition, savings rates have increased in recent years, which will help some households to smooth their spending.
The implications for monetary policy and interest rates.
The relatively downbeat outlook for households and the labour market is a key plank in our view that interest rates will eventually fall early next year. But while the strength of the economy and household spending seems clear and likely sufficiently weak to eventually bring inflation pressures to heel in a timely fashion, thus far inflation pressures have remained strong in defiance of those drivers. Data from offshore in recent weeks show resurgent inflation pressures that have caused markets to reassess the path for rate cuts in key foreign jurisdictions. Indeed, the market is now flirting with the thought of interest rate hikes in Australia. This emphasises the message we have been sending for a while – that the path to 2% inflation is likely to be a long and bumpy one. The labour market and inflation data in coming months will likely be key for the path the RBNZ takes this year and next.
One area where these changed market views on the path for global interest rates has been felt is in the FX markets. The USD has been relatively strong and the Kiwi dollar correspondingly weak reflecting both the USD strength and the market’s continued conviction that rate hikes won’t come on to the table in New Zealand. Reflecting these trends we have adjusted our forecasts for the NZD over this year and revised the NZD down versus the USD and most cross rates. While New Zealand economic momentum looks weak and interest rate expectations contained, it seems likely the NZD will retain a weaker tone.
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