A stronger primary export sector, increasingly stimulatory fiscal policy, and the continued need for more housing in Auckland shape as the key drivers of our predicted acceleration in economic growth during 2018. We forecast that GDP growth will peak at 3.7% at the end of 2018. However, labour capacity pressures in Auckland’s residential construction sector could still stymie growth over the next 18 months, while the spectre of property price falls is hanging over the housing market. Over the medium-term, the economy’s recent reliance on an expanding population and growing construction activity is likely to be exposed. By the early part of next decade, we predict that New Zealand will struggle to maintain positive growth on a per-capita basis.
New Zealand’s rate of economic growth has slowed this year, an outcome that we started warning about in 2016 as concerns about capacity constraints came to the fore. Although the slowdown has not been as drastic as allowed for in our forecasts – we have revised up the expected trough in growth from 1.9% in our July publication to 2.4%pa – the tone of those forecasts was correct. Economic growth looks especially lacklustre when considered on a per-capita basis.
So far, so middling. But with several other forecasters now expressing doubts about the economy’s prospects during 2018, we continue to predict a renewed acceleration in growth next year.
Recovery in export growth is underway
The most compelling driver of faster economic growth will be exports. In June, export volumes recorded their second-strongest quarterly growth result this millennium on the back of resurgent dairy and forestry volumes. Although a rebound in the dairy sector had been anticipated given last season’s difficult weather conditions, the timing was earlier than expected. As with dairy, forestry’s rise appears to be at least partly linked to improved commodity prices.
Outside these two stand-out areas, there is broad-based strength in export prices. In New Zealand dollar terms, meat prices have surged 10% over the last year on the back of a 15% lift in lamb prices. Aluminium prices have risen 17% over the same period, in line with a general trend of improving hard commodity prices. And inflation-adjusted export prices for fruit and vegetables are at their highest level in more than six years as the horticultural sector enjoys solid international demand conditions.
Our forecast pick-up in goods exports will drive total export volumes up by 4.2% over the year to September 2018. This result would be stronger but for the tourism industry, which is now striking more challenging conditions. Year-end growth in visitor arrival numbers has eased to a 20-month low of 9.3%pa, and even that growth rate has been inflated by 1.0-1.5 percentage points by the World Masters Games and Lions Tour.
Chinese visitor numbers fell in the 12 months to July for the first time in seven years. This slowdown reflects the fact that growth in Chinese visitors to New Zealand over recent years has far exceeded growth in the total number of Chinese people holidaying abroad – a trend that could not be sustained.
Only solid growth in Australian arrivals (up 6.3% in the last 12 months) has prevented a sharper slowdown in the industry.
More moderate increases in Chinese visitors will limit overall growth in tourist numbers throughout the forecast period. We predict that total arrival numbers will lift by an average of 5.0%pa over the two years to June 2019, with growth slipping back to average 3.1%pa between then and June 2022. This softer growth will give the government and tourism operators a chance to address some of the capacity pressures that have emerged due to the sector’s rapid expansion since 2013.
The perennial question of how high construction can go
The second major driver of our forecast pick-up in economic growth next year is the construction sector. Increased building activity has long been a feature of our expectations for 2018 and 2019 given the undersupply of housing in Auckland and mounting government efforts to try and address affordability problems. Furthermore, recent construction data has been slightly more positive than we had anticipated.
However, the real test for our forecasts will come during 2018. The property market has failed to stabilise in the wake of last year’s tougher loan-to-value restrictions, with sales volumes persistently falling since June last year, house price inflation slowing, and the average length of time for properties on the market still rising.
We are forecasting a decoupling of trends in the existing housing market and trends in residential construction activity next year. This decoupling is based around the pre-existing imbalances in Auckland’s housing market and the potential for direct government involvement in boosting the build rate. Nevertheless, achieving this decoupling becomes even more challenging given the labour capacity pressures that have been evident in the construction industry during the last two years.
Consequently, we recognise that the risks to our forecasts for construction and overall economic growth over the next 1-2 years lie to the downside. We forecast GDP growth to accelerate to a 14-year high of 3.7%pa by the end of next year, but an inability of the residential construction sector to meet burgeoning private and public sector demand could still end up being the overarching theme of the next 24 months for the economy. Although capacity pressures are less critical in the non-residential and civil construction subsectors, they also have the potential to limit future expansion in activity.
A bit of relief in migration and interest rates
Amid the sustained demand pressures being faced in the residential construction sector, there are two areas of minor relief. Firstly, we have revised down our net migration forecasts slightly since our last publication in July as the effects of National’s immigration policy changes have become clearer. This shift in our forecast has knocked nearly 13,000 people off the population by mid-2022, implying almost 4,700 fewer new dwellings will be required over the next five years than previously forecast.
Secondly, the threat of stress on the housing market and household budgets coming from rising mortgage rates is a little further off, with the timing of interest rate rises delayed compared to our previous projections. We have pushed out the first predicted interest rate rise by the Reserve Bank from May to August 2018, in recognition of persistently weak inflation pressures both domestically and offshore. From 2019 onwards, our forecasts of 90-day bill rates are 25-50 basis points lower than previously forecast, while our 10-year bond forecasts have also been revised down by as much as 40 basis points.
More stimulatory fiscal policy either way
At the time of preparing our forecast numbers, coalition negotiations and decisions were dragging on, making it difficult to be certain about the precise details of likely government spending and fiscal initiatives over the next three years. However, GDP data shows that government consumption spending over the year to June grew at 4.4%pa, its fastest rate since the end of 2008, when National came into power and the Global Financial Crisis hit. The increase in spending growth over the last couple of years coincides with the government accounts returning to surplus territory, enabling some loosening of the fiscal purse-strings. A bit more stimulus to economic growth ahead of an election is also handy for the incumbent party.
Whichever party New Zealand First chooses to support in government, we expect this trend of fiscal stimulus to continue. Both National and Labour have made election promises around infrastructure (roading or rail) and boosting the supply of new housing. National has tax cuts via threshold adjustments due to kick in from April 2018, while Labour would like to reverse these cuts and adjust Working for Families instead.
Perhaps most importantly, the “bidding war” to gain Winston Peters’ support is likely to include some fiscal initiatives in key policy areas for NZ First. We saw a definite change in fiscal direction following the 1996 election as National’s programme of tax cuts was put on the backburner and more spending was directed towards Winston Peters’ priorities. A shift was less apparent following the 2005 election, although the SuperGold Card was a sizable legacy initiative of NZ First’s support for Labour during that parliamentary term.
Perhaps the biggest wildcard is around Winston Peters’ proposal to shift port operations out of Auckland and up to WhÄngÄrei. Although this grand plan would take about ten years to implement, it would have significant implications for infrastructure spending across the port facilities in WhÄngÄrei, as well as roading and rail links between WhÄngÄrei and Auckland.
Is it all just a population phenomenon?
The re-emergence of faster export growth and the capacity risks around the construction sector highlight the possibility of a divergence in trading conditions for externally and domestically focused businesses over the next 12-18 months. This outcome would be the reverse of the last couple of years, when dairy has been a significant drag on provincial economies, while firms focused on construction and tourism have prospered.
Over the longer-term, the role of strong net migration and the necessary construction response in fuelling New Zealand’s economic growth during the last few years will become more apparent. Between December 2018 and December 2021, we are forecasting economic growth to tail off from 3.7%pa to just 1.4%pa. Slowing population growth will be part of the story – it is forecast to ease from 2.2%pa in March 2017 to 2.0% by the end of next year and 1.4%pa by December 2021. Per-capita growth is likely to be stronger in the near term than it is currently, but once we have got over the construction “hump” associated with the strong population growth that has occurred, prospects for the economy look less rosy. By 2021, our forecasts see per-capita growth barely staying in positive territory – a very weak result when compared with the average per-capita growth of 1.4%pa over the last 20 years.
Even in this environment, capacity issues will linger. We predict that the unemployment rate will hold at or below 5.0% throughout the forecast period, and wage inflation will lift back into the 2.5-3.0%pa range by the second half of 2018.
