Sharon Zollner: 2022 may be a year of economic normalisation

For a long time, central banks argued that cost increases caused by supply disruptions were ‘transitory’ and would resolve themselves quite promptly. They focused on shoring up confidence and demand with exceptionally low interest rates, and in many cases, including the RBNZ, providing extra liquidity and stimulus through ‘printing money’ and buying government bonds with it (also smoothing the path for generous fiscal stimulus).

But over time it has become clear that the hit to demand was sporadic and essentially temporary, given the massive fiscal support (like the wage subsidy) that was thrown at seeing households and firms through. Spending has bounced back quickly after lockdowns, and there’s also been a substitution from services to goods – ie from that European holiday to a new kitchen instead.

The supply disruptions, on the other hand, have been persistent, broad based, and highly inflationary. It’s not just shipping costs.

The mobility of labour has been impaired globally, not just in New Zealand, and this, on top of solid demand, has seen labour shortages evolve. That’s great news for workers in one sense, insofar as there are lots of opportunities out there; the tight labour market has made it easier for people to work flexibly and return from a period out of the labour market, but it’s also been a contributor to high inflation pressures. Even though the New Zealand labour market is the tightest it’s been in decades, with the unemployment rate just 3.2%, most people will find that their real income has gone backwards this year, since CPI inflation is running around 6%. If you got a wage increase any less than that – and that’s most everyone – you’re going backwards in terms of spending power.

But the tight labour market is sitting there primarily as a driver of future inflation, given wages react with such a lag. The biggest contributor to inflation to date is the housing market. There are various housing components in the CPI that have jumped (eg construction costs) but there’s much bigger impact than just that, via the impact on confidence and broader spending. Kiwis have been spending up like our syndicate won Lotto, even though as a nation we were made poorer by the loss of tourism income. Nothing like your house price going up to make you feel wealthier, even if it’s paper wealth – and those not lucky enough to own a house are no better off at all.
 

House prices in New Zealand have risen more than 40% since COVID first hit – and they were considered problematically high to start with. While rising asset prices have been a global theme, given the massive stimulus that has been unleashed everywhere, in comparisons of house prices to incomes, or house prices to rents, New Zealand stands out like a sore thumb. And that’s a vulnerability, there’s no getting around it, particularly now that central banks have realised they now have a big job to do to rein in inflation.

CPI inflation in NZ is running at roughly twice the top of the RBNZ’s target band (1-3%) and triple its midpoint. If it were just one or two one-off things pushing it around that would soon dissipate that would be fine, but it’s looking really broad-based, and all the measures of “core” inflation that try to strip out noise are all above the top of the target band too. That means it won’t go away on its own, and we are forecasting the Official Cash Rate to be raised steadily over this year and into next, taking it to 3% by April next year. Mortgage rates have already moved up a lot with the RBNZ already having raised the OCR twice and signalled more to come, but if our forecast proves correct, they’ll rise further yet.

Can the housing market handle it? We are forecasting house prices to drop around 7%. No one’s house price forecast should be taken as gospel – it’s really hard to forecast – but right now, the risks are looking skewed towards a harder/faster landing potentially, with recent policy changes impacting the availability of credit, as well as monetary policy impacting how much it costs to borrow.

But in the big picture, as long as the labour market remains tight, this will put a floor under any correction in the housing market, so a nasty correction remains in the risk basket should the overall economic picture change abruptly (a la 2008) but not a particularly likely scenario.

Overall, looking at the year ahead, the theme is likely to be volatility (not least from the imminent Omicron wave), rising interest rates, a higher cost of living hurting household budgets, and a slowdown in the housing market. Eyeing that list, it’s clearly likely to entail a less happy-go-lucky economic mood than much of 2021 featured. With stimulus being wound back, the economic signals will be to live within our means again, and those means are somewhat straitened, despite the strong labour market. But the year will also bring us closer to the rest of the world again, closer to the end of the pandemic, and hopefully, a calmer housing market that has stopped galloping ahead of income growth.

It might feel like tougher going, but when it comes down to it, it’s a more sustainable mix than the headiness brought about by the biggest housing boom New Zealand has ever seen. It’s looking like a year of normalisation on a range of fronts – not a bad thing when the past two years have been anything but.

This article first appeared in Woman Magazine's February issue.