That wasn’t so bad – but what about next year?

Data since we published our last set of forecasts in July has confirmed that the economy’s immediate bounce back from the initial COVID-19 lockdown has been better than expected. Labour market indicators, the housing market, construction activity, and household spending have all defied expectations of an immediate and sharp downturn. Despite this good news, we’re worried that the worst is yet to come, and we now expect more fallout to hit the New Zealand economy next year. Graph 1 shows that we are now forecasting the second half of a double-dip recession to occur in 2021.

Graph 1

The official unemployment rate of 4.0% for the June quarter was clearly not an accurate reflection of reality, but instead came about because of definitional issues. Stats NZ’s estimated unemployment rate of 6.2% for the final week of the quarter felt more representative. By that stage, back at Alert Level 1, the restrictions on job searching that affected the data from earlier in the quarter were no longer in play.

But even putting this definitional issue aside, the labour market has held together much better than was initially anticipated by all forecasters. A review of the September quarter unemployment rate predictions when we published our April forecasts saw them range between 7.2% and 11.1%. The range was still spread from 7.4% to 10.0% when we published in July. We now estimate that the September unemployment rate was just 6.5%.

Credit must be given to the government’s wage subsidy for limiting the immediate rush of job losses from the border closures, lockdown, and collapse in business confidence. Weekly additions to the number of Jobseeker Support beneficiaries averaged 7,160 during April amid a wave of reactionary redundancies from businesses. But since tailing off in mid-May, additions to the jobseeker queue have stayed relatively low, averaging just 784 per week. [1]

We believe that we are now at a crossroads for the New Zealand economy. If we can somehow avoid another substantial wave of job losses, then the negative flow-on effects for other key pillars such as the housing market and spending activity will also be muted. Alternatively, if the government’s wage subsidy and its various extensions have only delayed job losses, rather than prevented them, then we would expect to start seeing things unravel as businesses plan for the year ahead.

By the first week of October, there were about 94,600 jobs still being supported by the wage subsidy, down from a peak of 1.66m in late May. The fact that we haven’t seen this shift in the numbers translate into more job losses to date suggests that employers are adopting a wait-and-see approach. That approach is understandable given how well household spending activity has held up.

The next four months will be a crunch time for many businesses and their employees. Summer will be a key bellwether of fortunes. Retailers will be hoping that the post-lockdown buoyancy in spending can be sustained through into the Christmas period. For tourism operators, the absence of foreign tourists during the peak summer months could have a negative effect on their revenue three times as large as it did during winter. And other businesses will be weighing up trading conditions in the lead-up to Christmas, deciding whether it is worthwhile retaining staff and having to pay them through the holiday period if demand is going to stay soft into 2021.

We are not confident that further job losses can be avoided. Our updated forecasts predict a 6.5% decline in employment over the year to June 2021, implying a total fall in job numbers of 6.9% from its March 2020 peak (see Graph 2).

Graph 2

Although we have drops in employment built into our forecasts for every quarter through until June 2021, it is possible that these declines take longer to materialise and don’t show through until early next year. In other words, there is a chance that the employment data continues to be more positive than expected throughout the rest of 2020, without providing any guarantee that the labour market has dodged a bullet.

Nevertheless, our forecast loss of 186,000 jobs from peak to trough is a significant improvement from the 253,000 decline we were predicting in July or the 307,000 we anticipated in April. As previously noted, the government’s support has proven to be very important for the labour market, while job losses have also been limited by the New Zealand economy’s successful elimination of COVID-19 and quick bounce back out of lockdown.

It’s also important to note that simply looking at job numbers provides a simplistic view of the downturn’s effect on the labour market and the flow-on implications for consumer spending. Reductions in average hours worked are also a point of flex for the labour market when demand conditions soften. It will be telling how much of the 2.7% fall in average hours recorded in June’s Quarterly Employment Survey is recovered in September.

Anecdotally, earnings have also been more responsive to this recession than “normal” downturns. There were widespread reports of pay reductions for staff during lockdown, although these temporary cuts didn’t show through in either the Quarterly Employment Survey or Labour Cost Index. Nevertheless, growth in both these labour cost measures in coming quarters is expected to be at its weakest since the mid-1990s.

Declines in employment have a clear and dramatic effect on the spending power of consumers. But reductions in hours worked and a lack of wage inflation also have negative implications for household budgets.

Indicators to date suggest an immediate bounce back in household spending following lockdown, with private consumption in the September quarter likely to be similar to its pre-COVID level. However, Graph 3 shows that we expect 2021 to be much less positive as the labour market’s deterioration affects spending activity. We forecast a 3.2% fall in private consumption between December 2020 and September 2021, with household spending not surpassing its pre-COVID peak until the second half of 2022.

Graph 3

Private consumption makes up over half of New Zealand’s economic activity, so this forecast double dip in household spending gives the “W” shape to our updated outlook for overall GDP. Graph 4 shows that the “W” description is probably not entirely accurate, and could perhaps be better described as a “V-U” – a quick bounce back from the initial economic hit, followed by a more prolonged downturn and difficult recovery in 2021 and 2022.

Graph 4

Alongside household spending, the other important facet of the economy being buoyed by the labour market’s resilience is the housing market. Our previous forecasts of house price falls were premised on jobs being lost and people being unable to meet their mortgage payments. Throw in a collapse in population growth due to border closures and the recipe was complete.

Instead, we have so far been spared the worst of the job losses and, since our last forecasts were published in July, the government has extended its mortgage holiday scheme until March next year. No one is under pressure to sell their property, so the increasing pool of interested buyers is fighting over a limited number of houses available to purchase. House prices have defied expectations from six months ago and have actually gathered more upwards momentum.

It’s worthwhile outlining the contributors to this pick-up in demand for housing to better understand how long it might continue.

• Population growth unexpectedly spiked in late 2019 and early 2020. The pandemic created a pool of foreigners that have stayed in New Zealand longer than they originally intended (and longer than a year) due to border closures, reduced air connectivity, and visa extensions. There was also an influx of returning Kiwis in early 2020 who came back from their OE early or had been working overseas but chose to come back to live in New Zealand as conditions deteriorated offshore. Even if they are not homeowners, all these people have needed somewhere to live. Importantly, many of the working Kiwis returning at short notice from overseas will have been cashed up and keen to buy a house.
• Very low interest rates have proven to be more effective than we thought at enticing buyers into the market. First-home buyers have been particularly active, with new lending over the three months to August up 31% from the same period in 2019. As well as the boost to demand from lower mortgage servicing costs, parents are more likely to be helping their adult children get onto the property ladder, given the lack of return on their term deposits.
• Investor demand for property has also picked up, with lending growth over the three months to August sitting at 25%pa. The removal of the Reserve Bank’s loan-to-value restrictions effectively reduced the deposit requirement for investors from 30% to 20% (the latter requirement has generally been imposed by the banks themselves since the pandemic began). The lack of returns available from other investments such as term deposits has also driven up investor demand for property and shares.
• Where job losses have occurred, those people affected are on average more likely to be renters than homeowners. This uneven nature of the downturn so far has limited the negative effects on the housing market.

Add in the fact that neither the Reserve Bank nor the government want to see house prices fall, and it is becoming increasingly difficult to envisage a decline in property values in the near term. We still expect house price growth to slow in coming quarters in response to lower net migration and a weakening labour market, in combination with the significant continuing supply of new residential building activity in the pipeline. However, house price inflation holding between 0% and 2%pa between March 2021 and March 2023 is a much “better” outcome than the falls of 11% we were predicting back in April at the height of lockdown (see Graph 5).

Graph 5

We still see scope for downward pressure on house prices over the longer term as interest rates start lifting from their record lows and the market absorbs the big increase in supply that is currently being constructed. We have factored in modest falls in house prices during 2024 and 2025.

Auckland’s community outbreak in August was an unwelcome reminder that COVID-19 and its associated restrictions on business activity and freedom of movement can reappear at any time. From both a business and household point of view, this incredible level of uncertainty makes it very difficult to make major decisions or commit to significant future plans. Although businesses have shown increasing flexibility and agility in how they operate, we expect uncertainty to remain a constraining factor on spending and investment throughout the next year.

The on-again, off-again nature of the possible Trans-Tasman and Pacific travel bubbles has also made it difficult to reliably assess prospects for the tourism industry. For this set of forecasts, we have maintained a conservative assumption that travel bubbles start to open up from the second quarter of 2021. However, the recent move to allow New Zealand travellers into New South Wales and the Northern Territory without having to quarantine suggests that things might progress sooner.

Timelines for a COVID-19 vaccine also seem to be highly variable. Our forecasts have been prepared on the basis that a vaccine becomes readily available late next year. However, the roll-out of the vaccine will not necessarily be uniform around the world, and we can envisage some restrictions persisting throughout 2022 and limiting travel.

Year-end growth in government consumption reached a 14-year high of 5.2% in the June quarter and is likely to accelerate further before peaking in late 2020 or early 2021 (see Graph 6). It would be easy to pin a lot of this growth on COVID-19 but, in reality, spending growth had been picking up since mid-2019 anyway. Although the government’s reaction to the pandemic has added to that growth, the bulk of the COVID-19 response will show through as transfers (eg welfare payments), rather than as purchases of goods and services such as health and education.

Graph 6

Nevertheless, we still see upside risks to our projections for government consumption for two reasons. Firstly, forecasts have been playing catch-up to the quickly moving fiscal landscape over the last six months. Although we have revised up our projections again, they might still prove to be too moderate given the flows of money out of the government’s coffers.

Secondly, there remains scope for the government to introduce more fiscal stimulus to help the economy recover. The COVID-19 Response and Recovery Fund still has approximately $14b of unallocated money. The government has set these funds aside with the primary intention of providing economic support in case of further outbreaks, but we would not rule out some more active spending initiatives if economic growth looks shakier over the next year.

Alongside the scope for more fiscal stimulus, the Reserve Bank is set to implement further monetary policy easing in coming months. The Bank’s most recent Monetary Policy Review clearly signalled that a Funding for Lending Programme (FLP) is likely to be introduced before the end of this year. The FLP would effectively see the Bank provide longer-term funding to retail banks at an interest rate tied to the official cash rate (OCR), on the condition that the banks lend the money out to borrowers.

The Reserve Bank’s hands remain tied regarding the OCR until March 2021, given the forward guidance the Bank put in place earlier this year. However, expectations are now virtually unanimous that the Bank will push the OCR into negative territory in the first half of next year. We forecast that the OCR will bottom out at -0.5% and remain below zero until early 2023. Any divergence from this expected path would constitute an implicit tightening in monetary policy conditions.

These additional measures by the Reserve Bank will see longer-term interest rates remain lower for longer. We now expect bond rates to continue edging down until the second half of 2021. We have also tempered the speed of the recovery in bond rates throughout the rest of the forecast period (see Graph 7). By mid-2025, we expect the 10-year bond rate to be at just 1.2%, compared to a projection of 2.8% in our previous forecasts.

Graph 7

COVID-19 is not going away any time soon. Global daily new case numbers reached an all-time high of 385,848 on October 9, almost four times the highest daily total recorded in April. However, it’s important to note that this increase in case numbers reflects much more widespread testing than there was capacity for six months ago. Global death numbers averaged 6,306 per day in April; the corresponding number for September was 5,406.

Lockdown fatigue means that countries are reluctant to continue or reimpose significant restrictions on economic activity and people’s freedoms. But it is also clear that the ongoing threat of the virus is acting as a constraint on activity anyway. Even without lockdowns, people are more reluctant to venture out and about than they were pre-pandemic, and this hole in demand will have a lasting effect on economic outcomes. The latest Consensus forecasts show that, by June 2022, Spain, Italy, the UK, Japan, and France are all forecast to still have smaller GDP than they did in the September 2019 quarter.

Aside from the prospects of prolonged weakness in the world economy, which could extend for longer than most forecasters are predicting, the pandemic is also affecting people’s consumption patterns. Reduced spending on travel and associated goods and services is an obvious change, but our exporters are also being affected by lower levels of restaurant and hospitality activity that are hitting demand for higher-value foodstuffs. This trend is likely to show through in reduced incomes for meat and wine producers, for example, as they are forced to settle for lower prices from international consumers with a reduced willingness or ability to pay top dollar.

Concerns about international supply chains also remain on the radar. Imports of a range of manufactured products are well down from a year ago. Some of this decline will reflect weaker demand, particularly with regards to business investment spending. But there are ongoing anecdotes about shortages of electronics and other manufactured consumer goods.

At this stage, we remain reluctant to predict a pick-up in domestic manufacturing activity on the back of these issues. However, supply chain disruptions have the potential to constrain economic growth if they persist or become more acute in coming months.

It’s undeniable that the New Zealand economy has regained momentum following the chaos of early 2020. The effects of the pandemic on the economy to date have been less severe than we originally feared. But this downturn is still the most severe in living memory, and the path ahead remains highly uncertain.

We still expect the ramifications for the economy of the lockdown and border closures to persist for an extended period. Caution remains a key feature of our forecast outlook. One of the biggest risks is that New Zealand’s better-than-expected economic performance is not matched by a rebounding global economy.

[1] Trends in Jobseeker Support numbers are muddied somewhat by the COVID-19 Income Relief Payment. However, there has been a relatively small number of people moving onto Jobseeker Support after their Relief Payment entitlement has run out, suggesting many of these people are not eligible for Jobseeker Support.