There is still considerable uncertainty about the trajectory of the Covid-19 pandemic and its effects on the global economy. Inflation has risen worldwide recently and many central banks around the world will raise their policy rates to stabilise inflation in 2022, argues Dr Murat Ungor in part one of a three-part series on what 2022 might bring for Aotearoa. Read part two here.
GDP fluctuations to date during the Covid-19 pandemic
The emergence of Covid-19 and the measures to contain it since the start of the pandemic led to an historical economic contraction in New Zealand.
Gross domestic product (GDP) fell by 10.3 percent in the June 2020 quarter, the largest quarterly fall recorded since the current series began in the late 1980s.
New Zealand avoided a recession with promising first quarter growth in 2021. GDP climbed 1.5 percent in the March 2021 quarter following a December 2020 contraction of 0.4 percent.
GDP rose by 2.4 percent in the second quarter of 2021 but fell by 3.7 percent in the September 2021 quarter, the second largest fall after the June 2020 contraction.
The negative September 2021 quarter growth was mainly determined by the nationwide and regional lockdowns, which saw all major sectors – primary, goods-producing, and service industries – take a hit.
New Zealand’s economy is projected to rebound back to positive growth in the December 2021 quarter results, which will be released in March 2022.
The Government is no longer pursuing an elimination strategy now a significant majority of the population is vaccinated, and My Vaccine Pass is available to every New Zealander who is double vaccinated.
The new traffic light system that was rolled out in December 2021 has allowed many shops and businesses to open and offer services properly. These are good steps to revive economic activity.
ANZ, for example, forecasts a 2.5 percent quarterly growth for the December 2021 quarter. We will have to wait until GDP results are released to find out.
Are lockdown-induced GDP contractions over?
The answer is a cautious yes. On October 4 last year, the Prime Minister said “it has become clear that long periods of heavy restrictions has not got us to zero cases.” And Covid-19 is still with us.
There are still some cases of the Delta variant of Covid-19 in the community, while in managed isolation, an increasing number of people arriving from overseas are testing positive for the more infectious Omicron variant, which can also hit double-vaccinated people.
We cannot ignore the threat of Omicron spreading in New Zealand, as we have seen it spread quickly in other parts of the world. We must be ready and well-prepared for a possible Omicron outbreak.
On top of this threat, there are both domestic and international economic concerns, which suggest being cautious on the path of economic recovery. A specific economic challenge for 2022 is accelerating inflation.
Is inflation rising up, up and away?
Inflation is up almost everywhere and is becoming a global problem.
American consumers are facing the fastest inflation in almost four decades: the all-items consumer price index (CPI) index rose 7 percent for the 12 months ending December 2021, the largest 12-month increase since the period ending June 1982.
The UK CPI rose by 5.1 percent in the 12 months to November, its highest level in more than a decade.
The global inflation acceleration has many causes, including pent-up demand, lingering supply-chain disruptions, and rising energy prices, which have soared by 18.9 percent in the OECD area over the past year, the highest rate since September 2008.
The mess in the global supply chain is a major concern. Exporters struggled with surges in freight prices and shipping backlogs in 2021. Delays in deliveries and supply chain difficulties caused shortages occurring in supermarkets in various countries. Power shortages in China have affected production in recent months as factories were idled to avoid exceeding limits on energy use.
The supply chain problems are still with us. The city of Xi’an, a major economic and logistics hub in northwest China, was placed under a stringent lockdown on December 23, 2021. The city hosts many high-tech companies. Two of the world’s largest memory chip makers – Samsung Electronics and Micron Technologies – have facilities for research and manufacturing. Both companies raised their concerns for delays in manufacturing.
New Zealand consumers are also facing increasing price rises. Annual inflation was 4.9 percent in the September 2021 quarter, compared with 1.4 percent in the September 2020 quarter: (i) housing and household utilities increased 6 percent, (ii) transport increased 13 percent, (iii) food increased 3.1 percent.
These price increases do not affect all households in the same way because the consumption baskets of high-income and low-income households differ.
Inflation is particularly harmful for low-income households with rising food and energy prices as well as home rental prices. Cross-country evidence on inflation and income inequality suggests they are positively related.
2022 is going to be a tough year for economically vulnerable families and low-income households.
How are central banks responding?
Future inflation expectations continue to rise. The Treasury’s Half Year Economic and Fiscal Update, published on December 15, 2021, forecasts CPI inflation to peak at 5.6 percent in the March 2022 quarter.
Some central banks have already started to increase the interest rates to lower the inflation rates and some others will deliver hikes in 2022.
The Bank of England raised its main interest rate to 0.25 percent in December 2021 and in the same month the central bank of Norway raised the policy rate from 0.25 percent to 0.5 percent.
The Federal Reserve, the central bank of the US, is also expected to increase interest rates in 2022.
The Reserve Bank of New Zealand (RBNZ) implements monetary policy by setting the official cash rate (OCR). On November 24, 2021 the RBNZ raised the OCR by 25 basis points (a quarter of a percentage point) to 0.75 percent.
How much will the Reserve Bank have to raise the OCR, and for how long? I expect it will steadily increase the OCR until it reaches 2 percent by August 2022.
The OCR influences mortgage rates, so they would go up too. Mortgage rates have already increased 1.5-2 percent and are likely to increase a further 1-1.5 percent over the coming year.
If inflation persists and interest rates continue to rise, increased debt servicing costs for existing homeowners will be another problem.
2022 will be a challenging year for central bankers as they will continuously consider when and how to increase interest rates to control soaring prices.
*Dr Ungor declares he has no conflicts of interest.
