While the bank’s economists expect New Zealand will avoid a recession, they say the economy still faces an extended period of subdued growth because of tightening domestic financial conditions.

Westpac’s chief economist Kelly Eckhold says high levels of inflation are eating at household spending power, with associated large increases in borrowing costs. “In common with other advanced economies, inflation pressures remain hot.”

Accordingly, Eckhold maintains his forecast that the OCR will rise a final 25bp in November.  ANZ Bank is also predicting the OCR at 5.75%.

“Further monetary policy action is required to provide greater assurance inflation will fall in a timely manner. The OCR will not start its downward path until about a year’s time,” Eckhold says.

House prices

With population growth surging and expectations that borrowing costs are close to peaking, the sharp fall in house prices that began late-2021 has been arrested. Sales have risen from post- pandemic lows, and the relative stabilisation of house prices over the past few months means the bank now expects them to rise by almost 8% next  year – up from its previous forecast of 2.5%.

However, the combination of higher interest rates and higher living costs will be an increasing drag on households’ purchasing power, and many households will need to rein in their spending.

Rebound

GDP growth will rebound in the June quarter, says Eckhold. That’s in part due to a recovery from the severe storms and industrial action earlier this year.

Putting a floor under growth in the face of the above headwinds has been the rapid turnaround in net migration which is on track to reach 90,000 by year-end. “This upswing in migration is adding to the size of the labour force, helping to alleviate the staff shortages that many businesses have endured.

“It’s also providing a large boost to demand for many consumer goods, as well as the demand for housing and rental accommodation.”

He says the broader trend is for GDP growth to remain subdued this year and 2024, with unemployment rising from 3.6% to 5.2% by year-end. Wage growth is expected to gradually slow from recent highs. “Combined, that weakening in labour market conditions will reinforce the slowdown in household spending,” Eckhold says.

Adding to challenges for the economy has been weaker than expected activity in some key trading partner economies, notably China. “The related softness in demand is weighing on the prices of some of our key exports, with global dairy prices falling by an average of 21% over the past year, leading to weaker farm incomes.”

Scaling back

With profit margins squeezed and interest costs pushing higher, businesses have scaled back plans for capital expenditure. That’s seen lending to the business sector slowing from over 9% per annum last year to just 3%. Investment intentions have fallen sharply in the manufacturing and construction sectors. Similarly, on-farm spending (including capital expenditure) has wound back.

Election could change things

Following October’s election, there could be changes in some important policy areas, including potential changes to the tax system and further changes to environmental policies, Eckhold says.

“Another key area are regulations related to property investment, such as the rules around interest deductibility or the ‘bright line’ test for taxing capital gains on investment properties.

“As we’ve frequently highlighted, such financial factors play a major role in determining what happens to house prices. We’re currently forecasting moderate house price gains over the next few years but we’ll revisit that outlook if new policies are implemented.”

Hard decisions

He says regardless of who is in power after 14 October, New Zealand will face tough fiscal decisions.

“The 2023 Budget already pointed to mounting pressure on the Government’s finances, with the Treasury pushing out the time it’s expected to take for the operating balance to return to surplus by one year to 2026.

“We think the pressure on the Government’s finances could be even starker than the Treasury expected in May. Tax revenue over recent months is already falling behind Budget forecasts. On this basis, and factoring in our weaker outlook for nominal GDP growth (and hence the tax base), we anticipate that the 2023 and 2024 operating balances are likely to be a combined $9 billion below the Treasury’s forecasts.”

Putting this together, Eckhold says it means future Governments will likely face politically unpalatable choices between:

• reprioritising existing services to fund new Budget decisions i.e. cut spending; and/or
• introducing policy decisions to change revenue settings i.e. increase taxes.

He says alternatively, the Government could also borrow more and push out the projected return to operating surplus, but that would risk breaching previously stated fiscal targets.