Going Up, Going Down

Economist Cameron Bagrie takes a good, hard look at New Zealand and how we’re going as a nation.

Pop goes the balloon

Success has now created a challenge: how to contain inflation. Throw together Covid, supply chain bottlenecks, money-printing, low interest rates and huge government stimulus, and something will pop. Inflation is back, after being dormant for 30 years.

Housing backs up

House prices are down 4 per cent from their November 2021 peak and are likely to remain under continued pressure, given rises in interest rates and rising housing supply. Falling interest rates and looser monetary policy worked their magic lifting house prices. The effect cuts both ways. There are still pockets of resilience. Taranaki, Northland and Canterbury remain the better performers assessed by average across median sale price, days to sell, volumes, house price index, and sale to list price. Queenstown-Lakes district is another bucking the national trend.

F-grade

Headline inflation is high and two-year ahead inflation expectations sit at 3.3 per cent. That is a FAIL for the Reserve Bank, which has a 1 to 3 per cent policy band target. Having inflation outside the bank’s goal the odd year is OK, but not for this year and expectations of another two!

Close to a peak?

Inflation has hit 6.9 per cent. Some are blaming offshore factors, but actually inflation is a combination of both offshore factors and an economy that is exceeding its available capacity to supply, which puts pressure on prices to rise. This is inflation that the Reserve Bank can and will influence, by lifting interest rates.

Fighting inflation

Credibility and showing your inflation-fighting credentials remain the name of the game for central banks, which are facing the strongest inflation pressures we have seen for 30 years and need to slow growth. The talk is tough. Our Reserve Bank and the Bank of Canada both hiked 50 basis points at their last meeting and the US Fed is set to do the same.

How high will they go?

Financial markets are, at the time of writing, expecting the Official Cash Rate will rise above 4 per cent. That’s almost 400 basis points of tightening over two years, and the Reserve Bank has so far delivered 125 basis points. New Zealand has never seen around 400 basis points of increase over a two-year period. Mind you, we haven’t seen inflation around 7 per cent since the 1980s, either!

Too many houses?

Do the maths. When you have population growth of 90,000, which is made up of 60,000 migrants and 30,000 natural increase, and around 2.5 people per house, then add on a factor to depreciation on the housing stock, you need to be building around 40,000 to 45,000 houses a year. That changes markedly when population growth is 22,500 (30,000 natural increase less a net migration outflow). You need fewer than 20,000 houses.

Construction turns

House prices are dropping at a time when construction cost inflation (replacement cost) has hit 18.3 per cent. The ratio is known as ‘Tobin’s Q’ and signals a turn in the building construction cycle.

Credit wheels slow

Housing credit growth continues to ease, with annual growth easing from 10.5 per cent in calendar 2021 to 8.7 per cent for the12 months to March 2022, a pace of growth more normal and in line with income growth. This is being driven by a combination of higher interest rates curbing loan demand, loan-to-value ratio (LVR) restrictions, rising bank test mortgage serviceability rates, shifting bank risk tolerance and the impact of the Credit Contracts and Consumer Finance Act.

Hiring now!

One influence on inflation is a tight labour market, with the economy noted by the Reserve Bank as exceeding maximum sustainable employment. The more direct description is that the unemployment rate (3.2 per cent) is too low. Success in the form of the strongest labour market conditions in decades and too few workers for the jobs we have is now holding the economy back and driving up wage costs. That’s a good thing for workers but adds to costs and inflation.

Budget blowout?

Inflation is now household’s top concern, according to the IPSOS Issues Monitor, knocking housing off top perch. The cost of living rising is a concern, but so too are expectations the government will do something about it – and there are growing calls for spending to ease. The Reserve Bank has been open, saying government policy could help dampen inflation. ‘Help’ in the form of a big-spending 2022 Budget is not likely to be the help the Reserve Bank had in mind.

Rise of the non-bank lender

Many borrowers are now turning to nonbank lending sources for finance. Non-banks are less than 2 per cent of the home lending market, but in the past few months have been writing 8 to 10 per cent of the rise in the stock of home lending (new loans less repayments).

While Bagrie Economics uses all reasonable endeavours in producing reports to ensure the information is as accurate as practicable, Bagrie Economics shall not be liable for any loss or damage sustained by any person relying on such work whatever the cause of such loss or damage. Data and information have been gathered from sources Bagrie Economics believes to be reliable. The content does not constitute advice.

Correct as at 3 May 2022.