Economic dark before dawn as new year approaches

All signs point to the New Zealand economy moving from “a stagger to a shuffle” next year according to BNZ, which expects headwinds to ease towards the end of 2024.

This year was dominated by budget-stretching inflationary pressures and hefty interest rates, and BNZ chief economist Mike Jones expects those conditions to continue.

“This year has been challenging and difficult, more or less across the board, and it’s not looking like the economy’s going to race away next year,” Jones said.

“A lot of the challenges we’re facing now will carry through into next year, but I think the trajectory is one where things are starting to slowly turn, so we’re slowly stuttering to our feet. It’ll be a shuffle, it won’t be a full-on run or gallop by any means.”

It’s not all doom and gloom, with sentiment in some areas and sectors lifting a little, which Jones said suggested improvements over the second half of 2024.

“We don’t really see any growth occurring over the coming six months.”

He said the New Zealand economy was in a typical disinflationary period, “Businesses are seeing their margins squeezed, you’re starting to see workers’ wage demands being met less often than they were and the agricultural sector in particular is under pressure from sub-par offshore demand.”

With the Reserve Bank wanting to keep the official cash rate where it is or higher to wring out the last bit of inflationary pressure, Jones said 2024 was a dark-before-dawn scenario for the economy as a whole.

The Coalition

The most obvious difference between 2023 and 2024 is the new Government and the different brand of fiscal policy that comes with a swing to the right.

National’s tax changes mean greater income for middle-income earners, which Jones said would go straight back into paying the bills.

More cash in the economy brings a degree of inflationary pressure, but Jones said it could be offset by potentially big cuts in government spending.

“What we don’t know is the extent to which those two impacts net out. Our assumption for now is that there’s enough of an offset there that you don’t get a bunch of extra aggregate demand.”

Housing

Though the National, NZ First and Act coalition is still in its early days, one of the major areas of the economy Jones sees as being impacted by intended policy is the housing market.

“We’re going to see more investor participation in the housing market, which we see boosting demand and prices.”

The housing market isn’t without its troubles either.

A steep drop-off in consents being issued seen in the past few months indicates a drop-off in future work at a time when population growth is heading upwards faster than expected and increasing the demand for new housing.

“The answer we’ve come up with for that one is basically that the cost of building and interest rates are so high they are dragging residential construction in New Zealand down.

“Basically the maths just doesn’t add up at a macro level to get the residential construction activity that we need to satisfy the population growth we’re seeing,” Jones said.

Jones expects that will mean the average punter making a choice between building or buying an existing house will choose to buy because the price gap is so wide.

Jones does see the gap narrowing, but not in a way that solves the supply problem. Relatively more of the gap is expected to close through higher house prices rather than falls in construction costs.

Ultimately the bank expects house prices to rise 5–10 percent next year.

The pressure on housing means the rental inflation cycle will have further to run, adding pressure onto many household’s spending abilities.

Employment

The government’s labour market policy, in a space easing relatively aggressively because of higher-than-expected net migration, could see the process push along faster, with a pivot from an employee’s market to a more employer-friendly market.

After stirring all that into the forecasting pot, Jones said BNZ was left with a view that the overall mix might provide a little more support to the economy. That support is expected to come “mainly from that housing market channel, but, overall, it doesn’t really change our picture of the 2024 economy.

“The two big weights for us are interest rates and the global economy, and obviously the Government doesn’t have too much control over either of those.”

It is, however, asserting some influence over the Reserve Bank in winding back its focus on managing unemployment as well as inflation.

Reserve Bank chief economist Paul Conway has said the move means unemployment may rise further at the margins.

However, Jones and the BNZ economic team doesn’t necessarily take that view. “If you’re going to get inflation down, a lot of that will channel through the labour market anyway.”

Confidence

Fiscal policy moves typically have a lag before you see any real impact in the economy, and with many of the new Government’s changes not likely to come into play until part of the way through next year, they might not be a huge driver in the 2024 economy.

Jones said an uptick in business confidence,  which tends to coincide with a National government, is one of the more immediate impacts of the new Government. “Businesses are feeling a little less downbeat, a little more chipper, and that’s coming through, not just in the data, but I’ve been out on the road talking to businesses and was actually quite surprised with the mindset of getting on with it.

“Phones are starting to ring, and there’s an environment of businesses feeling more confident in putting investments in place that had been parked prior to the election.”

The link between business confidence, which has been rising for 11 months straight, and actual economic activity is not always clear, but Jones said if the lift in confidence was sustained it would be another marker pointing towards an improvement in the economic cycle next year.

“It’s not a champagne-cork-popping sort of scenario, but equally businesses are seeing light at the end of a tunnel, they’re seeing conditions improve, which does lend itself towards the trajectory of the economy starting to lift upward, instead of the end of 2022 when everything was pointing downwards.”

Interest rates

Though confidence has lifted in the private sector, Jones said the Reserve Bank seemed genuinely concerned that inflation wasn’t slowing as fast as it wanted. “The overall message we’re getting is you’re on your last warning, so any Reserve Bank meeting from here on out is potentially live for an interest rate increase if we see data that doesn’t align with the forecast they’ve put out there.”

Jones said the bank’s view was the economy, inflation and the labour market would fall off weaker than the Reserve Bank expects, and instead of lifting, they may be able to start thinking about lowering rates earlier than their projections imply.

He said financial market pricing was consistent with the central bank cutting twice next year, but the Reserve Bank has said that’s not on the cards.

“How that arm wrestle gets resolved is one of the keys for the economy next year. If the Reserve Bank is right and keeps interest rates where they are or lifts them, then we’re not going to see very much of a recovery or improvement in the economy.

“If the markets are correct, we’ll have lower interest rates from the second half of next year supporting an earlier turnaround, but it all comes back to inflation and whether it will decline in the manner we all hope.”

Inflation globally is falling quite rapidly at the moment and some comparative countries have inflation under three percent. “It doesn’t mean it’ll translate straight through to New Zealand and there are good reasons not to expect that, but things are going in the right direction.”

External shocks

New Zealand doesn’t exist in isolation and as an export nation reliant on a few key partners major economic risks and inflationary elements can come from offshore.

Jones said all the usual risks were lurking in the background as we head towards 2024, including tensions in the Middle East and Europe and the impact that could have on oil prices.

Jones said that the economic outlook in China was perhaps the number one risk factor. “We’ve seen the impacts of a weak China on our exporters.”

China is in the process of transitioning from its old ‘build and they will come’ model of growth. The very strong residential construction and investment built on urbanisation and population growth is rapidly slowing.

Jones said that shift was always going to be difficult and the Chinese authorities had recently recognised the need for more stimulus to resuscitate weaker demand, which had been felt in areas of importance to New Zealand such as dairy prices.

“It does seem we’re maybe past the worst in terms of the demand picture in China, it’s not going to reaccelerate fast enough to provide comfort for our exporters, but it does seem to be going in that direction.”

Just as New Zealand needs a strong Chinese economy, as an exporting powerhouse, China needs a strong global economy.

Wider political volatility is a larger risk than normal in the coming year, with just over half the world’s population going to the polls in 2024. “That’s happening in the context of fractured global politics, discontent, a shift to the far right in parts of Europe and the prospect of Donald Trump getting elected in November.”

“There’s definitely potential for some surprises and shocks dropping out of that, but it will undoubtedly shift the economic landscape in one way or another.”