Taken from Tea with Tony June 2022
This month in Tea with Tony, we ask if the global economy, and therefore little old New Zealand, is in for a case of long COVID? Are we heading into a recession in New Zealand, and could that be what is needed to reset our economic baseline? And of course, we dig deeper into inflation in New Zealand, interest rates and the housing market. Here’s Tony’s view.
Everyone seems to be talking about the ‘R’ word. However, Tony doesn’t think a recession is likely in New Zealand. The Treasury and Reserve bank don’t seem to be predicting one either, but there is a reality check underway in a lot of sectors out there.
Energy prices are soaring, which generally means world growth is slowing down. In some regards, supply chain disruptions are getting worse, following China’s eradication policy for COVID-19, cities, wharves, factories and transport networks are all shut down. The Reserve Bank is also raising interest rates very quickly and that’s exerting some downward pressure. House prices are also falling.
Tony says the reason we didn’t have a great depression scenario when the pandemic came along in 2020 is that governments, including New Zealand’s, ran large deficits. Central banks, including our own Reserve Bank, also slashed interest rates. We not only avoided a great depression but overstimulated our economies in the process. New Zealand consumers have been on a spending binge, which no one expected two years ago. We’ve spent money on Audi cars, spas, electric bikes and home renovations, which you don’t typically do if there’s a recession coming along.
If there was a recession, is it fair to say it is a reset of the baseline? And if it isn’t a prolonged issue, can it still have a decent reset in the economy? Tony thinks there could be a reset in terms of buying businesses time to adjust to a permanent shortage of labour. This allows them to more deeply consider the capital expenditure necessary to boost productivity. But the key one that economists are keeping an eye on is evidence of inflation in New Zealand not falling into a wage-price spiral, that the Reserve Bank will take some comfort that raising interest rates will not need to go so far as to deliberately create a recession. And we need to ask ourselves, could they do that? Well, yes, they did, Tony says. In 2008, the Reserve Bank created a recession in New Zealand , but that was partly because it took three years to get interest rates to such high levels. They are getting the job done now, within 12 months from October last year, so it is a different scenario.
The Reserve Bank of New Zealand has taken a much more aggressive stance on monetary policies. Tony says the big surprise is the Reserve Bank changing its forecast for when interest rates will peak from the middle of 2024 until the middle of 2023, lifting their projected peak from 3.4% to 3.9%.
Two years ago, when the central bank was predicting a depression scenario, they adopted a ‘least regrets policy,’ which is essentially what they would least regret getting wrong. They decided to deliberately risk cutting interest rates too far because taking the risk is better than easing too little and creating deflation—adding to deep recessionary environments. As a result, they eased too much and over-stimulated the economy.
The Reserve Bank now has a new least regrets policy. They realised it is better to take the risk of over restricting the New Zealand economy, raising interest rates too far, too quickly, and crushing growth. If they go as slowly as they did from 2005 to 2008, they risk inflation becoming entrenched and they want to avoid that risk completely.
Tony believes the economic consensus is that they left it too long to come out of very low rates. He thinks they should have started raising interest rates perhaps midway through 2021.
But Tony expects the interest rate pain to be over with relatively quickly. He thinks fixed mortgage rates will probably peak before the end of this year and some of the longer-term interest rates may come down a little bit before the end of the year because they want to get the job done quickly this time around.
The Reserve Bank forecasts 3.9% for the peak cash rate though Tony and most other economists are expecting a peak of 3.5% as they don’t think the Reserve Bank will need to take it to 3.9% if they see the restraint in the economy and inflation they’re looking for.
Tony’s monthly spending plan survey shows that consumers want to pull back on their spending for the next three to six months. So crunched consumer spending is happening, but the Reserve Bank will keep raising interest rates because they want to make sure the wage growth doesn’t take off. He says that’s a key uncertain element when you’ve got an unemployment rate of 3.2%.
Tony is expecting a 3.5% peak before the end of this year. For the two to five year mortgage rates, it could go for 0.5% more and for the one-year fixed rates, it could probably go 1% more. We’re looking at another 1.25% or 1.5% for the floating mortgage rates.
Tony says the extra credibility given to the Reserve Bank in controlling inflation means the curve is flattening. So that’s why there won’t be much increase for the medium to long-term interest rates, but there will be some as banks still need to rebuild some margin out there.
The Treasury predicts inflation will still be about 6% in mid-2023 and Tony agrees. Extra weakness is appearing in Tony’s monthly spending plan survey and in the residential property market. It has become even more of a buyer’s market over the past four weeks.
Tony says we don’t have to get back below the 3% level for the Reserve Bank to start cutting interest rates. Interest rates move in cycles and the Reserve Bank will shorten this cycle. The time when interest rates start falling will happen sooner than we expected because they want to get the economy crunched as quickly as possible.
The uncertain factor is that they have explicitly said the unemployment rate – 3.2 % is too low. There’s excess employment in the New Zealand economy and a wages risk, so they plan to raise the unemployment rate in the near future.
Could the government’s recent budget for 2022 and its inclusions like the cost of living further stimulate inflation? Tony’s take is that the budget is mildly stimulatory but not very much at all. 2.1 million or so people are getting $27 extra a week just for three months. Not many people are going to rush out and buy a new car or a couch on that basis, Tony explains. It will help with the weekly grocery bills and of course, the pressure on prices there is downward. The supermarket chains are highly incentivised to not raise prices at the moment or the government will come down even more strongly than has proven to be the case currently.
The Treasury projects the ratio of government spending to the size of the economy to decline in future years and revenue to go up. So, there will be a return to surpluses, hopefully in about three years. Thus, though it’s not technically helpful, this is not something that will greatly concern the Reserve Bank, Tony says.
Tony stresses that housing markets move in cycles and we have had many weird cycles over June 2020 through to November 2021 with house prices soaring about 45%. And now, there’s a reality check/ correction underway. On average, house prices have fallen 6% so far but Tony says that even if they had fallen 20% from their peak, it still only takes prices back to where they were at the start of 2021. So, it’s generally hard to take it seriously, apart from those who paid too much approaching the peak of late last year, like property developers. Thus, there will be some equity issues for some people out there.
However, Tony doesn’t think that’s going to cause a wave of mortgagee sales around the country. Banks are mainly interested in whether people can service their mortgages in New Zealand and keep making payments. With high job security and accelerating wage growth, the answer is going to be yes, people can keep servicing these mortgages.
A key characteristic you need for a proper route in the housing market is a lot of distressed sellers. But Tony says that the test interest rates have been so high that only a few people will pay a higher interest rate than they could service when they took out their mortgage. High job security and rising construction costs are insulating factors for prices as well. And as the Reserve Bank stated in the monetary policy statement, a lot of the consents that have been issued are not going to be acted on. These places are not going to get built and therefore, talk of an oversupply situation making people get even more cautious about buying is not going to be a reality.
Tony believes that people are going to actively look for reasons not to buy for the rest of the year. Talk of a brain drain in New Zealand and an oversupply in Auckland has people looking for excuses not to buy, even if they want to. So, what does this mean? Well, there’s a big backlog already of people that want to buy. By the time the housing cycle turns, the stack of people looking to buy will be even bigger than it is at the moment and there’ll be a bit of a catch-up phase on buying.
Tony’s advice to first home buyers is to not try to pick the bottom of the cycle. Instead, focus on the fact that the number of properties available for sale has increased tremendously over the past few months. There’s a good chance you’re going to be able to find the property with the attributes you want, but not necessarily the price you want. Be prepared to miss the bottom by 5-7% or so and don’t sweat that out. After a few years, it won’t matter so look for the property that best suits your needs.
As always, if you have questions about how a changing market impacts you and your home loan structure, we’re here to help. Book a free chat with your local consultant today.
*Please note: Tony Alexander is an independent economist. His views are his own and not necessarily shared by NZHL or vice versa. Tea with Tony is brought to you by NZHL in a sponsored capacity.