Little relief for households until 2025

Pressure on household budgets and a significant tightening in fiscal policy will weigh on economic growth during the rest of 2024. We have revised down our GDP growth forecasts throughout the next 18 months, and strong net migration means that per-capita results look particularly weak. The unemployment rate is still set to reach 5% later this year, despite labour market indicators taking longer to soften than we might have expected. Lingering inflation risks mean we have delayed our prediction of the first cut in the official cash rate until November 2024 (from August previously), although we still predict the official cash rate will have been lowered to 4% by the end of 2025. Economic growth will start to gather momentum during 2025 and 2026 as interest rates reduce, with GDP growth reaching a forecast peak of 2.9%pa by early 2027.

Financial pressure on households continues to be the dominant theme of near-term economic outcomes. Per-capita private consumption spending fell by 2.1% during 2023, the largest decline (excluding the 2020 lockdown-affected figures) since 1992, when a global recession combined with disruption caused by domestic economic reforms to cause a major downturn in activity.

We estimate that households are now almost 90% of the way through the increase in the average interest rate being paid across all mortgage debt in this tightening cycle (since 2021). Given there are limited further increases to come in the effective mortgage rate, we had been hopeful in previous forecasts that the trough in the economy during 2024 would be the fabled “soft landing”. But, if anything, the pain for some households is only really starting to show through now. Anecdotally, households have been burning through their savings buffers to keep up with increasing mortgage payments, and some are now running out of saved cash. There has also been a lift in the stock of homes for sale, despite weak demand conditions in the housing market, which also hints at increasing amounts of mortgage stress.

The effects of these pressures on households are not being felt evenly across the retail sector or the rest of the economy. Across almost all areas of spending, per-capita volumes are down, but the biggest declines over the last year have occurred in some of the more discretionary areas, such as clothing, footwear, restaurants, and hotels. The flow-on effects from weaker household spending will take time to come through and fully affect firms operating in the business-to-business space. However, the extent of the decline in household spending means these other segments of the economy will not escape some pain.

We now expect a 0.3% contraction in private consumption in the year to June 2024, which equates to a 2.9% decline in per-capita terms (see Graph 1), as it remains tough for businesses to convince people to part with their money. This sharper decline in spending in the near term creates scope for an earlier recovery in activity during 2025, but the labour market still presents a downside risk for spending over the next 18 months. We continue to forecast a lift in the unemployment rate from 4.0% to 5.0% by the end of this year, reaching a peak of 5.2% in 2025. That trend could lead to more prolonged spending caution from households through into next year, as they remain concerned about their job and income security.

Graph 1

Those concerns should have dissipated by 2026, and with interest rates also trending downwards, we expect a more definite pick-up in household spending growth. We forecast that growth will reach 3.0%pa by the end of 2026 and will hold at 3.0-3.5%pa throughout the rest of the forecast period.

It’s not only household budgets that have come under pressure – the government also continues to feel the pinch. Recent months have seen claims of fiscal “cliffs”, with government policies and spending programmes unfunded over the medium term resulting in less room for the introduction of new spending priorities or tax cuts. These issues have been exacerbated by fiscal “risks”, which had been identified but not quantified prior to the election, now materialising and requiring more government money. Additionally, weaker economic outcomes mean that tax revenue is tracking below Treasury’s forecasts, further reducing the government’s room to manoeuvre, and delaying the expected return to a budget surplus.

At a more tangible level, the effects of departmental spending cuts are now becoming apparent, with widespread job losses starting to be announced over the last few weeks. At a regional level, economic activity in Wellington will be disproportionately affected over the next 18 months by these cuts.

In previous forecasts, we have discussed the likelihood that the government’s plans for capital expenditure would be unable to progress as quickly as desired, leading to a hole in investment spending during 2024/25. These concerns remain valid, even with recent announcements around the Infrastructure Acceleration Fund, the Roads of National Significance, and a top-up to the government’s budgeted multi-year capital allowance. It is also worthwhile noting that the government’s drive to cut operational spending appears to be spilling over and having a negative effect on some capital expenditure programmes. Graph 2 shows that we are now forecasting a 4.0% decline in government investment spending during the March 2025 year, with growth not returning to positive territory until the end of next year.

Graph 2

Although we are not particularly surprised by any of these trends, they are all bad news for the broader economy, because they indicate there will be little government support that will change the economy’s momentum over the next couple of years. There must also be some doubt about the government’s ability to fully implement the tax cuts this year that it had campaigned on, without staggering the cuts over multiple years or making further cutbacks in government spending. A programme of slower tax cuts would provide less budgetary relief for households and potentially delay any recovery in consumer spending as well.

Finally, we note that any tax cuts will not necessarily be as inflationary as some commentators are suggesting. At their most simple, tax cuts would have a net zero effect on aggregate demand across the economy if any resulting increase in household spending was offset by an equivalent reduction in government spending – which is how the design of the proposed tax cuts has been set out so far. Furthermore, there is no guarantee that households, in the current economic environment, will spend all the additional money they receive in tax cuts. A proportion is likely to go towards reducing debt or increasing savings, particularly given that interest rates are relatively high at the moment – thus possibly resulting in a reduction in aggregate demand across the economy.

The extended battle to bring pricing pressures under control has seen inflation ease to 4.0%pa in the March 2024 quarter, its slowest rate since mid-2021. Inflation expectations across a range of surveyed measures are now back below 3%pa, but they are still about half a percentage point higher on average than the expectations that prevailed last decade.

These trends are consistent with our observations throughout the economy. The downturn in demand means that businesses are more reluctant to pass on cost increases than they were 18-24 months ago, for fear of further undermining their sales base. Nevertheless, there is still more buyer acceptance of price increases than there was prior to the pandemic – resulting in the lingering tail of inflation, particularly domestic of non-tradable inflation, that is more difficult to eradicate.

Although international inflation has moderated more quickly than domestic inflation, there are specific international risks that could temporarily drive a renewed rally in cost pressures. The most significant of these is unrest in various parts of the Middle East, including attacks in the Red Sea, the war in Gaza, and the potential for strikes between Israel and Iran to further spiral out of control. The flow-on effects into New Zealand’s inflation are twofold: via higher fuel prices that will be passed through into the cost of other goods and services, and through another round of elevated shipping costs that could temporarily boost inflation.

We now expect inflation to remain above 3%pa throughout the rest of 2024 (see Graph 3), with the risks outlined above meaning that the moderation could be even slower than we are forecasting. Apart from the inflationary risks already noted, we see two other specific inflationary risks. Labour cost growth could remain stronger for longer (see Appetite for workers must wane for our discussion of the labour market outlook). Additionally, large specific cost increases, such as insurance or local council rates, could keep both the headline inflation rate and inflation expectations higher than we have allowed for.

Graph 3

The Reserve Bank has recently stated that it has a high threshold for starting to cut interest rates – it needs to be confident that inflation will ease to 2%pa, rather than just heading back within the 1-3%pa target band. Limitations in the Bank’s ability to look forward when setting monetary policy suggest it might not have enough evidence to cut the official cash rate until late 2024 or even early 2025.

Given the greater persistence of inflation in the near-term, we have pushed our expected timing of the first official cash rate cut back out to November this year, rather than in August as we had previously expected. This slightly longer timeline until interest rates start to be cut is also reflected in expectations for other central banks around the world, as pockets of price pressure hang about in the system. We continue to predict the official cash rate will get down to a neutral rate of 4% by the end of 2025. Slightly more stimulatory monetary conditions could be implemented during 2026 and 2027, with the official cash rate getting down to 3.5%.

One of the key assumptions behind our forecast of softer demand, weaker spending activity, and reducing inflationary pressures this year is a continued easing in the labour market. The relative strength of the labour market over the last five months has been somewhat surprising – particularly in terms of employment growth. Despite job ad numbers sitting about 8% below their 2019 pre-pandemic level, monthly jobs data for January and February demonstrates that firms still have an appetite to take on more workers.

We do not expect this demand to be sustained in coming months, and we forecast that employment growth will slow from 2.4% to 0.5%pa by the end of this year. In tandem with population growth of about 2.0%pa at the end of 2024, this slowdown in hiring should drive the unemployment rate up to 5.0% later this year.

Private sector labour cost growth has eased over the last six months, but at an economy-wide level, this trend has been masked by large increases in public sector labour costs. Public sector labour cost growth has been pushed up by significant collective agreements for teachers and nurses coming into effect, as well as a catch-up in broader public sector remuneration following the wage freeze put in place during COVID-19. Nevertheless, the private sector response to the improved labour supply indicates that labour cost growth should ease further throughout the next two years, down from 4.3%pa currently to 3.2%pa by the end of 2024, and 2.7%pa by the end of 2025 (see Graph 4).

Graph 4

It's worthwhile reiterating that the labour market is typically the last part of the economy to turn and, within the labour market, labour cost growth tends to be one of the last indicators to change direction. Although the resilience of the labour market throughout 2023 has been somewhat surprising, we are comfortable that more of a softening will occur during the next 18 months.

The government recently announced changes to the Accredited Employer Work Visa scheme. The government is trying to pull back from the open-door approach that has prevailed since the borders were reopened in mid-2022, and it is wanting to focus more closely again on bringing in higher-skilled workers to fill specific labour market gaps. This approach makes sense given the increasing slack in the labour market, as the unemployment rate pushes up towards 5% and more workers within New Zealand become available.

This adjustment should help embed the decline in net migration that has started to emerge in the numbers since late last year. However, it will take time for the change to take full effect. We expect net migration to still be above 60,000pa, the average level between 2015 and 2019, until mid-2025.

In the near-term, this strong population growth will continue to stretch the capacity of the housing market and infrastructure networks. High interest rates and tight funding conditions will limit the construction response to meet the additional demand implied by the new arrivals to the country.

We continue to forecast that net migration will get as low as 19,000pa during 2026/27. This weaker net inflow arises from two factors. Firstly, the large arrival numbers during 2023 will lead to a higher-than-usual outflow of people in three years’ time as people’s work visas expire. Secondly, we expect Kiwi departure numbers to settle at a new higher level throughout the forecast period (see Graph 5), reflecting a perception of better living and working conditions in Australia that will continue to lure more people across the Tasman.

Graph 5

The increased churn associated with higher arrival and departure numbers affects different parts of the country in different ways. The higher arrival numbers will tend to boost population growth in the main urban areas (particularly Auckland), potentially exacerbating the housing and infrastructure issues mentioned above. There is also a risk that migrant arrivals continue to displace youth employment.

In provincial areas, though, the higher outflows of people make it challenging for these regions to retain their talent. The loss of young people overseas often needs to be mitigated by attracting workers from other parts of New Zealand with the drawcards of lifestyle and housing affordability.

The greater headwinds faced by the economy, particularly the persistence of more restrained spending activity by households, have led us to revise down our GDP forecasts throughout the next 18 months. We predict that economic growth will bottom out at -0.1%pa in June 2024, before recovering to 0.8%pa at the end of this year and 2.0%pa by December 2025. Lower interest rates, less contractionary fiscal policy, and the improving world economy will all contribute to a further acceleration in economic growth to a forecast peak of 2.9%pa in March 2027.

Graph 6

It is probably another 9-12 months before it feels like the worst of the downturn and post-COVID recalibration of the economy is behind us. For households, it is a matter of tight budgeting, prioritising their spending choices, staying in work, and awaiting interest rate relief. Businesses need to focus on keeping their costs down and operating as efficiently and productively as possible, knowing that demand conditions will generally start to improve from 2025.