An economic outlook for 2023 with Jarrod Kerr

In this podcast, the Relab team is joined by Jarrod Kerr, Chief Economist at Kiwibank, to take us through his insights into the current economic climate. 

Jarrod explains some of the reasons for the rapid inflation we have seen as of late, where he sees inflation and interest rates going in the next few months, and how this will impact next year’s economy.

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Transcript

Stacey: 0:56

Kia Ora And welcome to The Property Collective podcast brought to you by Relab. I'm your host, Stacey Fairclough, content manager here at Relab. In today's episode, I'll be talking to Kiwi bank's chief economist, Jarrod Kerr where Jared will take us through an overlook on the current economy with the focus on inflation interest rates and their effect on the housing market. He will also address what he expects to see over the next few months and going into next year. Let's get started. Jarrod, I'll pass the stage over to you. I'm sure there's plenty you've got to talk about today.

Jarrod: 1:32

Yeah, you're absolutely right. A lot has happened since the last time we had a chat. The global economy is, is softening. Obviously the war in Ukraine is an issue and, and Europe is under significant stress. Particularly coming into the cooler months with the energy crisis over there and United States looks like it's going to slow down as well. And, and you know, China is, is struggling. Their economic output is, is really weak and their property market is in distress. We're seeing substaintial declines in property prices in in China. Two thirds of their cities are recording declines in, in property values. So there's a significant correction happening in the northern hemisphere, but also when our region in Asia as well. And the outlook is, is particularly awkward. Then of course we have the cost of living crisis high inflation. We think inflation is peaking, but the path back down to more stable prices is looking a lot longer and bumpy. And I think central banks globally are worried about the outlook for inflation and they're becoming more aggressive. So we have very high inflation globally, it's running at 10%. We have inflation running at 7.2% here, which is very high. Central banks are reacting. Our central bank included our central bank was one of the first to start lifting interest rates. And given, you know, what we know today compared to when we last had this chat inflation is a lot more persistent and Central Bank will have to do a lot more. So we we're now expecting the cash rate, which is currently three and a half percent to be lifted to 5%, which is a substantial increase from here and that will have you know, material impact on property markets. I think property markets globally are being targeted after some, some very extraordinary gains in recent years. We can see that one of the main contributors to high inflation, at least initially, was the lift in in global shipping costs, which was associated with severe stress and disruption in global supply chains. The outlook, however, has improved dramatically in just the last few months. Global supply chains are, are freeing up. There's issues around China, obviously, but global supply chains are in a much better place than what they were a year ago. Delivery times are, are down quite substantially and, the price of shipping. So shipping costs have come off quite sharply. And speaking to our importer and exporter clients at Kiwibank, they're telling us that that the cost of shipping is, has come down dramatically, even though In a, in a rather awkward position in the global map. And often get charged a lot more than than elsewhere in the world. The costs of shipping has come down quite dramatically, which is a really positive development and one that I think will contribute to lower inflation into next year. So that's great news and the other large contributor to global inflation has been the spike in commodity prices particularly the spike in oil. We've seen oil prices jump to, to very high levels in a very short space and time. But again over recent months it looks like commodity prices globally are declining, which is great. Oil prices have come off with the slow down in, in global growth and the expected slow down. In, in global growth, we're seeing commodity prices come off and oil prices have dropped. So, you know oil prices are one thing and, and they go into every, just about everything we consume, but other commodity prices as well, like copper and other key commodities are, are also weakening. So again, that's great news. And it will feed through into lower inflation outcomes over the next year. And, and it will continue. We will see commodity prices fall further as the global economy slows down. So there's some good news out there. The fact that shipping costs have, have come off so much, but also the stress on supply chains. It is reducing it's freeing up. And, and that is really good news. Thinking about our inflation we had our inflation report out just last week. It surprised us all on the high side. So the headline rate, the, the rate at which inflation is increasing only came down to 7.2 from 7.3, we, we had all expected inflation to drop into the sixes, you know, around sort of 6.7, 6.8%. It didn't happen. And the underlying measures of inflation were strong. So if you think about where we get our inflation from, we are getting roughly half of our inflation from the global economy and the fact that a global inflation is running at 10%. Our tradables, our imported inflation is, is running at about 8.1 percent, which is very high. So we're importing. A lot of inflation. And then there's our domestically generated inflation, the stuff that comes out of our housing market for example. And, and that is also running well above levels that, that we would be happy with. You know, domestically generated inflation's running at 6.6%, which is very high. And, and it looks like these price pressures are going to ease into next year but it's, it's a journey. It's a path which is still quite persistent, particularly with the tight labor market and wages rising the way they have and are going to. Where are we getting most of our inflation domestically well it's coming out of the housing market? Residential construction, construction in general and, and New Zealand is, is very expensive and we've seen a sharp increase in prices of building a home or, or, or doing any, any other type of construction in New Zealand. That's a bit of a global theme as well. Australia's also facing very high construction costs. It's, it's the, it's where we are in this cycle. You know, the, the cost of building a home is up over 20% in the last year, which is huge. It's a massive spike in materials costs, labor costs, the cost of getting stuff done. And again, we think it's peaking, but. The rate of of deceleration in prices is, is something that concerns us. So what, what does that mean? Well, when you have high inflation, and, everyone will know that inflation's, you know, above 7%. It's very high, and there's a very there's a worrisome outlook for, for inflation. People's expectations on where inflation is going to be in a year's time or in two years time increase. Naturally you see inflation increasing. The prices of everything that you are doing, that you're dealing with are increasing. So your expectations of where inflation and and prices are going to be in the future also increase, and that's the behavioral side of things that the Reserve Bank gets worried about. When people start expecting inflation to be higher and higher, then that becomes entrenched in our price setting behavior, and, you know, our wage negotiations, they all increase and we're seeing that now. People's expectations of where inflation's going to be are very high according to surveys done of, of households and businesses. Inflation's not expected to return to the one to 3% target ban for another two to three years. That's too long. And it's not expected to go back to, you know, the, the stable 2% run rate for at least another five years. So from the Central Bank's perspective, the RBNZ's perspective, they, they're failing they're failing on their mandate. Their credibility as a central bank is being questioned. Our central bank is one of the most passionate inflation targeters out there. We were the first, RBNZ was the first central bank globally to officially target inflation in the late eighties. And they're very passionate about that mandate and they are failing. So when you are failing you can't allow that to continue. You have to do something and the Reserve Bank has been doing something. They have been lifting interest rates, but it looks like they're gonna have to lift them further. So as of right now the Reserve Bank has, has told us that they're going to increase the cash rate to around four, four and a quarter percent. That's based on old information. When they come in and give a decision late in in November they're going to increase their forecasts. They're going to increase their OCR track, they're going to increase interest rates and we think they deliver a 75 basis point hike in November to four and a quarter. And we think they'll signal that they're going to take the cash rate to at least 5%, which is obviously a, a big jump up from the four, four and a quarter that they told us in August. So a lot's happened between August and November. And the main change has been that the much higher inflation readings than, than any of us had anticipated. Now of course, when you're hiking interest rates the whole point of lifting interest rates is to reduce demand within your economy. Not much they can do on the supply side. They can only watch and observe their tool of lifting a cash rate, lifting interest rates is very much designed to reduce demand, and mortgage rates have increased. You, You would've noticed that mortgage rates have increased over the last week following that, that very high inflation report last week. They're going to go higher still. And you know, the, the main catalyst will be that November March policy statement Now, interest rates have increased dramatically over the last year. You all know this, you, you know what mortgage rates are doing and where they've been. We had record low mortgage rates record, low cash rate. Last year the cash rate was just a quarter of a percent. Now it's three and a half, going to three, going to four in a in a quarter. Mortgage rates have, have more than doubled and in some cases tripled over the last year. So it's a massive increase in interest expense. For households with debt. It's great for savers. Savers were complaining a lot in recent years about getting very low interest rates. Now they're getting much more reasonable interest rates on their savings, but of course, people with debt have gone from mortgage rates of around two to 3% to looking at mortgage rates around six, 7% and higher. So that is a a massive increase in, in interest expense and it's going to be felt right now. So monetary policy works with the lag. So they, they lift the cash rate, but it takes a while to feed through the economy, particularly because most of us with mortgages, we fix our, our mortgage rates for 1, 2, 3, 5 years. So it takes a while for those higher rates to come through. Most of our mortgages are rolling off in the next six months. A large chunk of our mortgages roll off over the rest of this this year, so people who have fixed for one or two years at very, very attractive interest rates are now rolling off and are facing much higher interest rates. So the pain on households, the pain on the property sector. Is coming through as we speak right now and over the next, over the next few months. So we will see, I think, a substantial tightening in monetary conditions and, and, and a tightening in household budgets. Their ability to spend particularly on discretionary items is going to come into question In the next few months, and this is where the rubber hits the road, this is where the impact of all these rate rises that we've seen over the last year hit the economy. And we think it's going to cause a, a significant slowdown in growth. Of course. Over the last couple of years, we've increased our debt a bit in, in housing that was by design. The Reserve Bank slashed interest rates deliberately during covid to stimulate credit and to stimulate mortgage growth, and they did that. So the amount of mortgages that the amount of debt that we've taken on as an economy has increased in the last couple of years. That means that we are more interest rate sensitive. So we've got more debt. And with higher interest rates, it's going to become, you know, that much harder to, to pay off. So the Reserve Bank is increasing the extraordinary stimulus that they delivered during covid. So obviously they slashed the cash rate. They did quantitative eazing and they did everything they could to stimulate growth. Now we have overstimulated growth. We have too much inflation, central banks. Especially the RBNZ are now in the process of trying to unwind that stimulus and actually tighten conditions to slow the economy down. And it's a global phenomenon. It's, it's happening everywhere. What that means is, is we obviously face a period of, of very awkward growth. Our economic growth has been quite strong over the last decade. We obviously had the massive disruptions. From Covid, but our forecast growth over the next few years is much softer. We're expecting our economic growth over the next few years to be below trend, to be below potential. And that's on the back of this very, very large increases in in interest rates. It will cause a slow down in our economy. One of the largest constraints, if not the largest constraint in the economy right now is the labor market. Businesses are screaming out for workers. We've had no migrants or very little migrants coming into the country for, for three years now. In fact, we've actually got a net outflow of Kiwis from the economy. So it's very hard finding workers, and it's right across industries. It's right across skill levels, low skill workers to high skill workers, you know, people in agriculture, to people in banking. Across the board there is a, a real shortage of labor and you can see that when unemployment rates fall. You start to see a, an increase in wages. That's what we call the Phillips Curve. It's a beautiful curve invented by a Kiwi economist Bill Phillips, and that it's a relationship between unemployment or tightness in your labor market and and wages. And, and right now we're seeing wages pick up quite sharply cuz businesses are really struggling to hire and they're actually struggling to retain staff. There's a lot of turnover. In the labor market in New Zealand at the moment. So this is a, big constraint on the economy, on, on our ability to grow. And it is pointing to substantial increase in the costs that that businesses face. And when we ask businesses, How are you feeling? What's going on in your world, what worries you? The labor market's probably the, the first thing they'll, they'll say, so, employment intentions. So businesses, intentions to hire are still very, very high. They're struggling to find workers, and then when you've ask them, Well, what about your investment intentions? What about your willingness to, to buy new machines or expand your business? The confidence has collapsed in, in business circles, particularly around the future and willingness to invest for the future. And that worries me. That worries me a lot. When businesses stop investing, when businesses, you know, are forced to deal with a bunch of fires that are happening right now in substantial increase in cost, and they don't have their heads up looking to the future, that kills growth instantly. And I think that's what we're going to see. Businesses are telling us that they're worried they don't have the confidence to invest particularly small to medium size enterprises. They're worried and, and I think that so long as that continues and it will continue, I think, into next year, growth in our economy is gonna be affected. And we are gonna see a slow down, as I mentioned before, but it's, it really is around what businesses are feeling and, and they're not. They're not happy. They're downbeat. And you can understand why their cost base is increasing quite sharply, which not only labor cost, but the cost of materials, the cost of importing, exporting, all this sort of stuff is feeding through. To increase costs and their, their perceptions around profitability and, and, and how profitable they're going to be over coming months and years has, has, has been hit quite hard. So that really does worry me. And it's also been matched unfortunately by households confidence. So when you ask people on street. How are you feeling? Are you worried or, or are you happy? They're worried again, just like businesses consumer confidence has been hit quite hard and it's been hit by a number of factors. Most people have a job and they're quite happy and they, and their earnings are increasing, but they're worried they're worried about rising interest rates and what that does to'em. They, they're worried about the very high level of, of inflation that they're having to deal with the cost of living crisisand for most people they're worried about their house price. House prices are declining in New Zealand and that feeds through to confidence in households and businesses as well. So that really has taken a hit. And consumer confidence is at the lowest level since the 1980s. So it's consistent with very slow growthif not a recession, which is something we're worried about now. Just to complicate things further, I feel I need to talk a little bit about migration flows. And we're actually currently going through a relatively unusual period for New Zealand, but a period where we're actually seeing a net outflow of Kiwis overseas. So after a number of years under Covid Lockdowns and inability to really travel. A lot of Kiwis are now heading overseas for their oe or, or permanently. And we've seen a net decline in migration, one that we think will end up being around 20,000 shortfall. This year. We expect migration to return to more normal levels next year, but right here, right now we're seeing an exodus of, of kiwi's. So again, that that's dampening demand in housing market. We like to take a pulse of what's happening around the economy. We have various, you know, banks around New Zealand and, and bank managers and mobile mortgage managers all the way through the country. And we, we tap into that network and we ask them what they're seeing. And we also look at the economic data for the regions. And you can see that there's been a really interesting development in the last year in that, this time last year, the economy was running hot really hot. And when we look at a map in New Zealand, a heat map in New Zealand, It was red hot no matter where you were in New Zealand. You know, property prices were running very high levels in aggregate across the economy. House prices were up 33% in the year to August last year. And we saw that across all the regions. So the whole of New Zealand was running red hot now, just a year on from the last time we, we had a look. The economy is much cooler and economic activity is much lower. The housing market is in decline especially in Wellington and Auckland, but also spreading through the regions and in much lower house price growth and, and contractions and parts. And that has, has meant that New Zealand is, is much cooler and the economic scores that we are getting are very low. They're around that sort of three to four level out of 10, three to four outta 10. In terms of economic activity and confidence, it's been hit very hard in just a year and quite clearly that is on the back of, of much higher interest rates and a fall in housing market. It's impacting the local economies around New Zealand. And another thing which is, which is interesting is, our traffic levels are much lower than what they once were. It looks like when you go around the regions, you can see that the amount of traffic out there is, is lower than what it was prior to Covid. I think this is a better, more efficient economy than what we had, and it's one that includes a lot of people working from home now, so not traveling as much. And I think it's a, a more efficient, greener That we live in, so that's good. But we're not expecting traffic levels to return back to pre covid times. And we hope that that persists. But again, it's it's one which is. I guess softening the outlook for for CBDs you know, places where people go into work. I think we'll see, you know, a lower demand there, but more demand in the, in the suburbs, which is a natural change, I think, to post covid for anyone who's interested in the, In the currency one of the, Issues now faced by our economy is one of a, of a weaker New Zealand dollar. New Zealand dollar has declined about 20% against the US dollar, and it's declined against some of the other currencies as well. But mainly the US it's a US dollar strength story. The Kiwi dollars come off. So what does that mean? Well, if you're an export, You're doing back flips right now. Not only your commodity prices holding at high levels that they're declining, but they're still at high levels. The amount of New Zealand dollars you get by selling your commodities in US dollars or, or, or other, or other currencies is, is much higher. So our lower currency works really well for our exporters and is gonna help our tourism industry as it comes back on board. So there's some good news there. But a declining currency means it's more expensive for imports. So anyone who, who is an importer is facing a significant increase in, in costs. And that also means that the inflation that we are importing is, is going to be pushed higher by a weaker New Zealand dollar. It's great for exporters, It's great for a large part of our economy, but it's also frustrating the outlook for inflation over the near term. Now getting to the nitty gritty what's happening with, with housing? Well, prices are declining. You will know this wellington's down about 17%. I think that's weather affected. And we've got house prices down about 11% in Auckland. And then you see you know house price growth in, in the regions and, you know, likely contractions in the regions coming through. We think, you know, across the board house prices are down around 8%. We think that that house prices will fall about 13 to 15% by the end of this year. And then we think things stabilize. We're already starting to see some signs of stabilization in the property market, which is great, particularly coming into spring and summer when most of the activity occurs. It'll be interesting to see how the housing market plays out over the next six to nine months. We think it bottoms and starts to stabilize and actually see some increases in house prices next year. Again, migration will be part of that story as migration numbers pick up next year. But also the fact that the housing market is still largely undersupplied. And there is a shortage of of dwellings, and we can see this in, in all the data that everyone is well aware of, you know, the, the days to sell is increasing. The fact that that property is, on the market for longer means the total number of homes up for sale, the total number of listings is also increasing. This is a pretty clear cut signal that the housing market has weakened and, and may weaken a little further. Before stabilising but we are expecting these things to turn around next year. And when we think of the housing market, we really do think of it in terms of supply and demand. You know, what's the demand doing? Well, we had the largest migration boom in this country's history between 2013, 2019. It was an extraordinary amount of inbound migration. The largest we've seen I think in history. And then we had covid. And over that Covid period, obviously migration dropped to zero. And we've had a big change in that demand dynamic. So we had a long period of very, very, strong population growth, obviously increase in population means an increase in demand for housing. We're now going through a period where the flow of demand is, is much softer. And the supply side has seen a really substantial increase in the number of homes being built every year, which is fantastic. We are running down this shortage of dwellings that we'd built up over that 2013 to 2019 period. We've basically created through under investment, a massive shortage of housing in New Zealand of about a hundred thousand homes. Now we're going through a period of, lower demand, you know, lower population growth but a massive increase in supply. So the housing market is becoming better balanced. We are running down this, this huge shortfall in homes that we have, and I think in coming years, we're gonna find ourselves with a housing market that that's much better balanced and that's better for everyone. It's better for affordability. We are hoping that there'll be a lot more cheaper dwellings coming on to the market that lower end of the, of the spectrum. It's much needed and I think we'll find ourselves with a housing market that that is much more better balanced in years to come. And it is, it is important. You can see. That we have seen such a surge in supply where we've noticed it in all the, the metrics that we follow from, you know, building consents to electricity connections, these sorts of things. They've all, they've all increased. It's all very positive. And it's very important cuz when you look at cities and you look at how many dwellings have been created and, and built. The more you build, the better balanced your, your housing market is. There are some cities where, like Auckland, we just simply haven't built enough dwellings and that has caused quite unsustainable and unreasonable gains in prices particularly. Land based prices are a supply issue. The more we can free up supply, the more we can free up land then, you know, the much better balanced our housing market will be. And I think that is the way we are heading. And I, and I hope we can really iron things out for our economy, for the better.

Stacey: 29:13

I will ask a question. I remember last time we did have a bit of a conversation around Canterbury keeping up with a lot of their supply, and do you think that's helped them be a bit more stable compared to the rest of the country? Seeing in hindsight what's happened?

Jarrod: 29:31

Yeah, absolutely. You're right, Canterbury's a bit of a standout and for obvious reasons, You know, having an earthquake and then going through years of rebuilding they're, they're at a point now where they've actually supplied, you know, a lot of homes. They've supplied a lot more than than other cities for example by necessity and, and they're obviously rebuilding. But the fact that they have built so many homes relative to population has made their market a lot, a lot more stable. They didn't get the same increase in prices that we did in say, Auckland or, or Wellington or elsewhere. They didn't see that same dramatic run up in price because their housing market was better supplied. They're much better balance d and declining as much now. So it works both ways. You know, Canterbury's housing market is a lot more stable than others. And again, it's because it's better balance and it hasn't gone through these excesses that that other markets have. So, yeah, I think Canterbury is, is a lot more stable than other parts because of their housing supply demand dynamics.

Stacey: 30:34

Cool. And where do you see interest rates peaking and starting to come down?

Jarrod: 30:39

Yeah, so our guess is that the cash rate peaks at 5% early next year. So that means mortgage rates are starting to factor that, or have factored a lot of that in now. So I think. Overcoming months, we may see mortgage rates lift, you know, a little more, but they're, they are starting to, they have factored in the fact that the cash rate's gonna continue to increase to 5%. So I'm hoping that, you know, over the end of this year we see mortgage rates peak you know, only a little bit above where they are now. Given that they've all been lifted in the last week. And then I, I think the next move from the Reserve Bank is going to be rate cuts. So they get to 5%, they hold there for a while to make sure inflation's under control. We think inflation comes under control into the second half of next year, and that's a global story and then I think that central banks have be in a position to start lowering interest rates again if not at the end of next year, then, you know, early in 2000 and 24. And, and I think a lot of that's driven by the fact that all central banks are tightening quite aggressively now. They're all lifting rates now. And, and it's going to work, I think the fact that 75 central banks globally are lifting interest rates to fight inflation, I think they will win that battle. Unfortunately in the process of winning that battle, there are going to be recessions in Europe and the uk, maybe the US and parts of Asia. So we're gonna see significant slowdown in growth and that will then lead to, you know, interest rates being eased.

Stacey: 32:08

Do you think those other countries will have quite a big impact on us, or what do you see happening there?

Jarrod: 32:15

Yeah, definitely. We're a very small open economy, just like Australia, Australia's tiny, right? And we're smaller than Australia. We are very, very small economies who have large export sectors. We, we export, we deal a lot with the world, a lot more than most other countries. And we are going to be heavily impacted by what happens to global growth, particularly growth in in Asia, right? Our largest trading partners, China. China's going through a very awkward period at, at the moment. So I think demand from our largest trading partners is going to slow quite what it already is slowing quite quickly, and that'll then feed through into lower commodity prices and potentially lower volumes for us next year. But we will perform better than most economies around the world.

Stacey: 33:06

And how does probable energy supply disruption in the coming years factor into this analysis?

Jarrod: 33:14

That's a good question. Something I haven't looked at or, or thought about in great detail, I think I think we are reasonably well balanced, particularly given we're predominantly hydro. So I guess, you know, the disruptions there are more around weather and, and droughts. And. Potentially that causing an impact? I, I think there's a lot happening in the energy sector trying to become more renewable, more stable. It's going to take time just to sort out. But you know, energy disruptions here are much lower than overseas. And I'm not sure if this question's actually for US or for Europe. If it's for Europe then it's a massive. Massive disruption that will I, I think, induce a recession over there. It's just a matter of time. I think it's, it's happening now. It's going to get worse and Europe will be in recession because of, you know, that energy disruption.

Stacey: 34:08

Is NZ heading for a session?

Jarrod: 34:10

Yeah, we, we'll get very close to it. I think. If we don't actually get a proper recession, we'll get something that feels pretty close to it. Again, we think it's probably short. This downturn over the next six months to a year, the central banks will then react the other way. But yeah, look, I think we're, we're in for a period of very low growth in New Zealand as I showed on that chart. Household consumption will be key. To this outlook and, and I think we'll see you know, potential fall cons, contractions in, in activity and spending over the next six months. So, yes, I think given the very high levels of probability for recessions overseas. You know, it's a much high probability here that we go through one as well, particularly with the Central bank that's gonna hike to 5%. I only think the central bank needs to hike to four, four and a half percent, but it's not what I think they should do. It's what I think they will do. And I think they will hike to 5%, which will be. You know, I think a little, potentially a step too far. So yes, we are gonna see a significant slowdown and, and there's a good chance of recession. Cool. I think that's a good place to finish up there. Thank you so much, Jarrod that was really informative.

Stacey: 35:23

And that's a wrap. A huge thank you to my guest today, Jarrod Kerr from Kiwibank. This was a great deep dive into the current economic state. Thanks so much for tuning in. Mā te wā.