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Weekly Economic Commentary 24 June 2024

Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.

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Activity off the boil while inflation simmers

The latest GDP figures revealed that economic growth in the early part of the year was a touch firmer than we had expected. However, that’s still left us with a picture of weak economic activity, and recent indicators point to ongoing softness through the middle part of this year. Questions remain about the persistence in inflation and what that means for the RBNZ’s future policy stance.

New Zealand’s economy grew by 0.2% in the March quarter. While that’s certainly not strong growth, it was ahead of the 0.2% contraction that we had been expecting. It also means that New Zealand has narrowly avoided slipping back into recession. 

But whether-or-not we are technically in recession doesn’t really tell the whole story. Stepping back from the normal quarter-to-quarter swings, the longer-term trend in economic activity remains weak. Over the past 18 months economic growth has stalled, with the level of activity effectively tracking sideways. And even that flat result has been flattered by strong population growth – in per-capita terms, economic activity has fallen 2.4% over the past year. 

The weakness in growth reflects the impact of some powerful economic headwinds. Most notably, continued high inflation and high interest rates are constraining both household spending and business activity. Soft demand in some of our key trading partner economies is also weighing on export earnings. 

More recent economic data indicate that growth has remained subdued as we’ve moved into the middle part of the year. In the household sector, our latest survey of consumer sentiment showed that spending appetites have continued to weaken as the public comes to terms with the RBNZ’s message that rate cuts are some way off. Similarly, in the business sector the latest PMI and PSI reports have highlighted subdued sales and orders, with notable weakness in the services sector. Soft demand and continued pressures on businesses’ margins have been a consistent theme in our own discussions with businesses in some of New Zealand’s regional centres recently. 

We expect that growth will remain subdued over the remainder of this year. However, we do need to put the current downturn into context. The slowdown that we’re now seeing follows a period of rapid growth in the wake of the pandemic. In part, that was due to pent-up demand after the lockdowns. But what really lit a fire under demand was record low interest rates and expansionary fiscal policy. Those conditions pushed the economy well beyond sustainable levels and saw inflation surging to multi-decade highs.

Demand is now moving back into better alignment with the economy’s supply capacity. That seen most clearly in the labour market: while unemployment has risen from the record low of 3.2% that we reached in 2022, at 4.3% it’s currently around average, rather than elevated levels. 

Furthermore, even with the downturn in demand, we’re still not spending within our means. We’re still running a current account deficit of 6.8% of GDP, a level typically more associated with an overheated economy, not one in recession. Of course, there are several reasons why this deficit has blown out – tourism earnings haven’t fully recovered from the Covid shock, outbound travel is still in a catchup phase after the border closure, and global inflation has ramped up the cost of our imports. But these just reinforce the point: as a nation, we’ve taken a big hit to our international purchasing power, but we haven’t adjusted our spending habits to reflect this.

Importantly, although growth is cooling, New Zealand is still grappling with some strong inflation pressures. Overall consumer price inflation is running around 4%, with domestic prices (aka. non-tradables inflation) up 5.8% over the past year. 

Those lingering domestic inflation pressures were the focus of a recent speech from RBNZ Chief Economist Paul Conway. The speech noted that “There are some reasons to think that inflation may be more persistent than in our current projections in the near term.” That’s because many components of domestic inflation have been ‘sticky’. In fact, outside of the construction sector, non-tradables inflation has shown scant signs of cooling even with the sharp slowdown in growth that’s occurred over the past 18 months. Notably, those price rises are not limited to items like council rates or insurance. Instead, domestic price pressures are widespread, which is something the RBNZ can’t look through. 

We agree with the RBNZ’s assessment about the strength of the near-term inflation outlook. We’ve frequently highlighted that inflation pressures are strong and widespread. And our forecasts for this year are in line with the RBNZ’s projections. 

Where there is more uncertainty is the medium-term outlook for inflation, and on this front, the RBNZ has noted some reasonable questions about how inflation pressures will evolve. The RBNZ noted that there are “some reasons to think that inflation could fall more quickly than expected over the medium term.” That includes the emergence of spare capacity in goods markets and the labour market which could dampen inflation. The RBNZ has also highlighted the role that easing inflation expectations could play in helping to pull down inflation. 

As noted above, we’ve already seen a cooling in the labour market, and we expect that will continue over the coming year. Combined with softening demand, that has already resulted in inflation in some discretionary spending areas cooling. However, we need to see more adjustment in pricing in the services sector, which may take a while as the total pull-back in output in the last 18 months has been relatively modest – albeit prolonged. At the same time, we still expect continued stickiness in areas like government charges (like rates) and insurance – something that is not factored into the RBNZ’s forecasts beyond the very near term. That means the RBNZ could be surprised to the upside in relation to domestic inflation over the medium term. 

Bottom line, with the RBNZ signalling upside risk for inflation in the near-term, we think they’re unlikely to ease their foot off the brake soon even with growth slowing (in contrast to market pricing for earlier rate cuts). Consistent with that, the key sentence in the speech noted that the RBNZ still expects that “a period of restrictive policy is necessary to give us confidence that inflation will return to target over a reasonable timeframe”. This is not a different position than the RBNZ took in May. We don’t see that shifting in July either. 

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