The Reserve Bank has reviewed monetary policy and left its official cash rate at 5.5% as had been universally expected. Why universal? Because inflation is too high at 6% to justify any rate cuts in the near future, but the outlook for inflation is improving as prospects for our economy deteriorate.
The deterioration is coming from one source principally, but with two others adding to the weakness. The main cause of more open discussion recently about the NZ economy going back into recession late this year is the deterioration in China’s economy.
China provides one-third of our export receipts.
The situation there has become so worrying the authorities have called around economic analysts in the country telling them not to produce negative reports on the Chinese economy. They have also ceased publication of the youth unemployment rate which has just reached 21.3%.
The relevance for us is less volume demand for forestry, and much lower prices for milk products. Already Fonterra have cut their projected payout for this current season by one dollar and a further reduction looks likely.
One thing we economists have learnt over the years is not to under-estimate the lagged impact on city economies of recession in the primary sector and therefore regions. It tends to creep up on you and there is one factor in particular which can hide the rural deterioration – strength in the residential real estate market. I will come to that in a minute.
First, what are the other factors suggesting a less good outlook than we were thinking just three months ago?
One is fiscal policy. Whichever party wins on October 14 will have to initiate a series of spending cuts and revenue enhancements because of a deterioration in the government’s accounts.
The situation won’t be as bad as when National took over from Labour in 1990 and 2008, but tighter fiscal policy will act to slow the pace of growth in our economy.
A second extra negative in play is strength in the US economy.
This is causing fresh rises in US wholesale interest rates, and in turn, these rates affect similar rates in other countries. In fact, rises in America have already fed through into higher bank funding costs here which have pushed bank mortgage rates up an extra 0.25% or so beyond what the Reserve Bank was seeking in order to suppress growth.
The coming weakness in our economy on the face of it would imply at a minimum no recovery in the housing market and maybe a continuation of the weakness since late-2021. But there are many other factors in play covered extensively in this column all this year which will keep the recently developed upward momentum continuing.
Principal among these factors is the 87,000 or 1.8% boost to our population from net migration flows in the year to June. More people means greater demand for accommodation. This first affects the rental market and then stimulates greater demand for houses to own with upward pressure on prices.
Stimulatory also is the shift in buyers at the margin from new-builds to existing properties because of stories of losses by some on such purchases. This shift probably won’t last beyond 2024, but for now it means higher demand for existing listings. Speaking of which, listings are down 15% since the start of this year and still falling. Eventually awareness of this decline will bring buyers into the market earlier than they might have been planning a few months ago.
If National win on October 14, then their policy of restoring interest expense deductibility for landlords will likely bring some investors into the market to follow the first home buyers who have been active since February. The magnitude however is impossible to know.
Finally, over 2024, interest rates will be easing at an uncertain pace and as stress tests set by banks decline, many currently ineligible and highly frustrated buyers will be able to make a purchase.
There are other factors, but all up they suggest that even as our economy holds weak until perhaps mid-2024, the real estate upturn is highly likely to continue.
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