We still expect economic growth to slow to about 2.0%pa this year due to a softer export performance, capacity pressures in the construction sector limiting growth, and household spending slowing in the face of high debt levels. Next year looks more upbeat for the economy as export volumes recover and export prices remain high. Strong net migration and low interest rates relative to global averages imply that there is plenty of international confidence in New Zealand’s medium-term prospects. However, there are downside risks to migration if NZ First has a say in government policy following this year’s election. Putting aside this risk, the rise of automation suggests that real wage growth will be more restrained over the medium term than previously anticipated, with employers able to adopt more labour-saving capital.
So how slow might GDP growth get this year? We’re forecasting growth to ease to 1.9%pa by December 2017 – slightly slower than the 2.0% trough predicted in our April forecasts. Two of the key domestic influences on the growth outlook remain much the same.
Household spending will not be able to maintain the rapid 4.6% growth of the last 12 months – a 12-year high. Even with strong population growth continuing to boost the overall size of the consumer base, we expect households to become more cautious in their spending habits in the face of the slowing housing market, high debt levels, and the spectre of rising interest rates. Growth in private consumption is forecast to ease from its current rate of 4.6%pa to under 3.0%pa by early 2018. Solid population growth and a tightening labour market will prevent more of a slowdown in household spending.
Construction activity is being hampered by capacity pressures and, to a lesser extent, the flow-on effects of the tighter loan-to-value restrictions imposed on the housing market. Both factors are being felt most critically in Auckland, where residential building costs have risen 8.0% over the last year and 30% over the last four years (compared to one-year and four-year increases of 5.8% and 20% respectively for the rest of the country). The pressures are evident in planned activity with year-end growth in new dwelling consents is sitting at 9.3% in Auckland but 20% around the rest of the country (excluding Canterbury). Even so, capacity pressures are evident in non-residential building subsectors in Auckland and in other parts of the country as well, albeit not as intense.
A little less stress in the labour market
Although capacity constraints remain critical in the construction and tourism sectors, we anticipate that labour market pressures across the rest of the economy will not be quite as strong this year as we’d previously expected. The combination of slowing economic growth and persistently strong net migration has recently led to an increase in jobseeker numbers in some regions, and we expect this lift to be reflected by an unemployment rate of over 5.0% for the June and September quarters. A little less stress in parts of the labour market will keep wage inflation subdued in the near term as well.
We have also reconsidered our wage growth forecasts over the medium term given increasing discussion taking place about the future of work and the rise of automation. From 2020 onwards, we have pulled down our forecasts of real wage inflation by about 0.5%pa. We believe businesses will be encouraged to circumvent labour shortages and keep costs down by increasing the rate with which they adopt labour-saving technology.
Exports: prices hot, volumes not so much
Perhaps the most disappointing area of the economy in recent months has been the export sector. Export volumes have contracted 4.7% since mid-2016, the worst performance in eight years. Some of this drop reflects poor weather conditions last spring, which negatively affected dairy production, while disruption caused by the November 2016 KaikÅura earthquake might also have played a part.
Nevertheless, the outlook for the goods export sector is brightening. The temporary nature of the one-offs in 2016 means that volumes will lift over the coming 12 months and catch up some of the “lost” growth from last year. And a broad-based lift in export prices provides a strong incentive to increase production where possible. ANZ’s commodity price index shows that world prices for meat, dairy, forestry, and aluminium are at their highest in real terms in 2-3 years. Horticulture and seafood prices have not been higher, in real terms, since the early 1990s. On the back of these factors, growth in total export volumes is forecast to pull out of negative territory and reach 3.8%pa by September 2018.
The terms of trade provides ample evidence of how well export prices are doing. The index easily exceeded our expectations for the March quarter and has surged 11% over the last six months to its highest level since June 1973. We predict that the terms of trade will surpass its 1973 peak this year to be just 2.6% shy of its all-time high in 1951.
Graph 1.5 shows that we have taken a relatively conservative view on the terms of trade over the 2018-2020 period, with average export prices slipping back from their current peak and improving economic growth internationally reducing global spare capacity and putting some upward pressure on import prices. Thus the risks to our terms of trade forecasts over the medium term appear to be on the upside.
Prospects for services exports are less clear-cut. Although year-end growth in overall tourist numbers is still running at close to 10%pa, and will be boosted by British and Irish Lions supporters in the near-term, there has been a worrying slowdown in Chinese visitor numbers. Year-end growth in Chinese tourist arrivals eased from 42%pa at the start of 2016 to just 1.1%pa by May this year, the weakest result since 2009/10. Air capacity on China-New Zealand routes is down from a year ago, and anecdotal evidence suggests that New Zealand is now seen as relatively expensive by Chinese visitors given the price increases associated with capacity pressures over the last few years. New Zealand has enjoyed more than its fair share of China’s expanding international tourism sector over the last few years, and slower growth in tourism-related exports appears assured from the second half of this year.
Education exports are also feeling the squeeze. The value of “education-related” travel exports in the balance of payments is still up 12% from a year earlier, although that growth rate has slowed from the 21% peak recorded in mid-2015. Annual international arrival numbers on student visas have dropped 16% since February 2016 following the government’s clampdown on English language requirements. Although there have recently been signs that arrival numbers might be levelling out at about 50% above their 2013 level, the use of study as a “back-door” way to get residency in New Zealand remains open to political scrutiny.
Migration’s post-election risk
If there’s one area of the economy that is at risk of significant change following this year’s election, it’s international migration. Current polling suggests that National will get just enough votes to squeak back into power with the backing of its current support partners – the Maori Party, ACT, and United Future. But the numbers are on a knife edge, and it is possible that National will need NZ First following September’s ballot.
Winston Peters has a well-established anti-immigration stance and, with immigration arguably contributing to the housing market’s imbalances, cutbacks to visa approval numbers could be high on his list of demands in return for his party’s support. This myopic view conveniently ignores the fact that the increase in foreign citizen net migration flows (excluding New Zealanders and Australians) makes up less than half the increase in overall net migration since the last trough in 2012. Furthermore, with work visas making up 48% of foreign citizen arrivals over the last year, compared with 37% in 2010, true net migration is possibly being overstated by more than in the past, given that people arriving on work visas are subject to a greater level of churn than people arriving on residence visas.
Our forecasts predict a near-term peak in annual net migration at around 72,400 in the second half of this year, gradually easing to 35,800 by mid-2022. This forecast, which implies population growth of 1.3%pa in five years’ time, reflects the continuation of a relatively strong performance by the New Zealand economy that keeps attracting foreign migrants and expat New Zealanders and discouraging Kiwis from heading overseas.
Some adjustment in migration flows and population growth back down from its current record highs is likely and, arguably, necessary over the next five years given the stresses that such rapid growth has placed on the housing market and infrastructure, particularly in Auckland. However, our message is that the role of foreign workers in the labour market’s expansion cannot be shut off overnight without creating a whole new set of imbalances in the economy that will negatively affect New Zealand’s economic growth.
It would probably take until late 2018 before a marked change in government policy and, perhaps just as importantly, political rhetoric about migration would start to undermine potential growth. Significant constraints on foreign migrants coming into New Zealand would result in slower growth in the working-age population, leading to capacity pressures becoming more intense and widespread across the labour market. Labour cost inflation and, ultimately, non-tradable inflation would be driven up, forcing the Reserve Bank to tighten monetary conditions more sharply and thereby slowing growth in domestic economic activity.
Less risk associated with New Zealand?
Migrants have not been the only evidence of people willing to take a punt on New Zealand’s economic performance remaining strong over the medium term. The gap between domestic and international 90-day bill rates is at its smallest in 18 years, while the bond gap hasn’t been smaller since 1994. In other words, the risk premium associated with investing in New Zealand has been driven down as our GDP growth has outperformed growth in most other developed economies.
In the case of bill rates, it seems, the market believes that New Zealand’s good run has further to go. Consensus forecasts for bill rates see the gap shrinking to a post-1985 low during 2018. A consistently strong growth performance over recent years, low inflation, and an improving outlook for exports are all aspects boosting investor confidence and pointing towards the continuation of good returns in New Zealand.
Having said that, we think the Reserve Bank’s forecast of GDP growth hitting 3.7%pa in early 2018 combined with the official cash rate on hold at 1.75% until mid-2019 is a little far-fetched. Even with a more moderate growth projection, we still expect the OCR to begin rising from the middle of next year as labour market and domestic inflationary pressures start to build.
