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28 June 2018 Economic Market Update – Tony Alexander

ByJulie Halligan

From Tony Alexander, BNZ Economist

Migration Stimulus Easing Slowly

The stimulus to NZ growth and extent of housing market pressures from net migration flows continued to ease in May. There was a seasonally adjusted net migration inflow during the month of 5,090 people which was the third lowest monthly total in three years. The annual net migration gain has slipped to 66,243 from a peak of 72,404 in July last year and the underlying annual number based on recent monthly seasonally adjusted results is about 61,000

What is driving the easing of the net migration flow? The number of people coming to NZ has fallen by only 0.2% over the past year and was down by 2.8% in the three months to May from a year earlier. The number of people leaving however was up 9.5% in the year and 5.2% in the three months versus a year ago

So as tends to happen we have one side of the ledger going up while the other side of the ledger is going down. This is why the net flow can at times change quite radically and last did so from late-2012 when outflows fell while inflows soared.

Where are things heading? Given the goodish state of the NZ economy yet some downward revisions recently to forecasts for growth overseas it is difficult to buy into an argument that the net flow is going to fall away exceptionally quickly and soon be below the average annual flow for the past ten years of 31,000 per annum.

And one interesting characteristic of the rise in the number of people leaving is that it is being driven entirely by non-citizens departing rather than Kiwis leaving. The number of non-resident departures in the year to May was 30,520 compared with 25,041 one year ago and 22,201 two years back. The number of Kiwi citizens departing in the year to May totalled 33,446 which was little changed from 33,398 one year ago and 34,195 two years back.

This rise in non-NZ departures could be driven by long-studying students going back home. And speaking of going home, Kiwi businesspeople doing that at the end of the day indicate they will be flopping on the couch with heads hung low. The monthly ANZ Business Outlook survey this week showed a new decline in business confidence about where the economy is heading to a net 39% pessimistic in early-June from 27% in May. Confidence has collapsed since the Budget which might reflect or explain the new Finance Minister’s hermit-like behaviour.

http://www.scoop.co.nz/stories/PA1807/S00029/business-pessimism-doubles-costs-rise.htm

As noted here a couple of weeks ago, there is a natural decline in business sentiment when Labour are in power. This time around is no exception, especially in light of the ham-fisted policy changes made so far.

Should we be worried and talking about the Reserve Bank being forced to ease monetary policy? Not necessarily, but tightening seems a long, long way off especially considering the deterioration in conditions offshore (trade war, emerging economies declining, wobbly sharemarkets, fracturing Western alliance).

A net 9% of businesses still expect their activity levels to go up. But excluding the immediate post-election collapse from 22% to 7% this is the lowest reading since the middle of 2009. Only a net 1% of businesses now plan boosting staff numbers (from 7% in May and 15% pre-election) and a net 4% plan boosting capital spending – down from 13% pre-election.

Why are businesses so down in the dumps and spitting the dummy when interest rates are low, the currency non-threatening, commodity prices very high, consumer sentiment about average, and order books long for many?

According to businesses their key concern is inability to find skilled labour. After that they are worried about regulations (Fair Pay Agreements coming along for instance). Credit availability may also be a factor in the construction sector. Ability to turn a profit is probably also a big concern with a net 13% of respondents expecting their profits to go down. This is a nine year low.

These profit worries probably reflect a growing feeling of inability to control costs in a capacity-constrained economy, and inability also to easily raise selling prices as we have discussed here previously.

The resulting squeeze on margins is going to see some businesses unable to quickly adapt and boost efficiency/cut costs simply closing down. We know this is already happening in the construction sector with the extra problem of lack of certainty about timing and quantity of resource flows (cement availability etc.).

So it would be wrong to simply lay the low level of sentiment completely at the door of the government. The business sector itself is part of the problem and unless businesses lift investment to boost labour productivity the tight labour market and lifting of minimum wages will cause deeper and deeper pain.

The NZ business sector is clearly struggling to function in an economy less and less constrained by a lack of demand and more and more constrained by a lack of supply – with the overlay of heightened consumer response to price rises caused by easy access to price-comparison technology.

Does this mean slipping NZ GDP growth toward maybe 1%? Not necessarily given the list of stimulatory factors. But it does mean that should the world economy take a turn for the worse perhaps because of a widening trade war, the impact on business spending and hiring plans could be sudden and sharp. Risks have flipped to the downside.

NZD

I don’t tend to write much on currencies these days – mainly because neither myself nor any other economist can produce any record of good forecasting. An exchange rate is the door through which every single piece of new information about an economy and the one on the other side of the equation passes. New information appears all the time. So even if you can produce a model or a commentary explaining a currency’s past movements that does not mean you can actually generate a believable forec

With regard to the NZ dollar generally though, I struggle to go too far beyond the near record level of the terms of trade, firmish growth near 2.5% in coming years, net inward migration, and worrying political and economic developments offshore – all suggesting a good level of support for our currency.

The big bugbear however is and for some time has been the tightening of monetary policy in the United States. Their tightening and us not doing so implies downward movement in the NZD against the greenback. This has happened. Will it keep happening? In the short-term the risk seems that it will because monetary policy tightening here remains a long, long way off. Yet further tightening in the US is expected this year and next.

In addition, as a peripheral trade-dependent nation the deteriorating global trading environment being created by President Trump, and the worries surrounding currency selloffs for emerging economies, suggest further NZD weakness.

But again, our economic outlook remains good. The budget balance is in good shape and government debt levels are low. The Reserve Bank have done a good job of reducing risk in bank lending books. And the current account deficit remains well below average

Perhaps all this means is that exporters don’t want to get too greedy regarding locking in hedging the next time events conspire to push the NZD down by five cents. And keep in mind that at some point all of the expected tightening of monetary policy in the United States will be factored in and attention will turn to our tightening – if and when it ever occurs. Note that 100% of all forecasts of a sustained tightening of monetary policy in NZ have been wrong since 2009

Two specific things bear watching. The extent of downward revisions to global growth forecasts if the trade war deepens. Reaction of President Trump to China’s easing of monetary policy this week and possible encouragement of a weaker currency.

If the trade battle leads to the opening up of a currency front then exchange rate uncertainly will soar.

Trade War

As tensions escalate between the United States and its major trading partners and President Trump initiates moves looking like they will lead to an all-out trade war, how concerned should we be?

If a complete war does break out the disruption to trade flows, business operations, capital flows etc. can only be negative for world growth. That will affect us in terms of some downward pressure on export prices and inward visitor numbers along with reduced consumer and business confidence. The impact on exporters will be slightly muted by some weakening of the NZ dollar. But this will act to reduce living standards for consumers via higher prices and raise input costs for many businesses.

All we can do is wait and see where things go. But a very important point to note is this. No country is erecting barriers with the primary aim of protecting domestic farmers. China aims to negatively affect electorally important US farmers through some of their tariffs on the likes of soybeans, ginseng, cranberries and orange juice. But they are not looking to artificially boost the incomes of their own farmers. The EU is taking the same approach.

This is important because it means that the chances of barriers being erected specifically to keep our primary products out are not as high as one might think. And it is notable that the EU and China are working together to try and preserve a rule-based multilateral trading system rather than a one-on-one deal focussed approach which President Trump is pursuing. Nevertheless, it is hard to see anything other than downside growth risks as tit for tat tariff imposition continues. This implies downside risks for share prices, as well as interest rates even though tariff rises will boost inflation in some countries – most notably America

Housing

The Housing Minister has admitted that there is not enough capacity in the NZ construction industry to achieve his house building goals. So he is pursuing a new strategy of encouraging the private sector to build factories to make prefabricated houses.

The idea is a good one but it takes a long time to design, build, then make fully operational such production lines, and it is not guaranteed that construction-related firms with sufficient capital to do it will want to. There are many hurdles to overcome.

  1. Being sure that a market actually exists for prefab houses. Kiwis tend to associate (incorrectly probably) the word “prefab” with lesser quality school rooms on squat wooden poles. In this day and age of social media-initiated destruction of reputations and ideas, one anecdote of bad prefab quality with a decent photo attached could be enough to sink the market. After all, we are all wondering what the next leaky buildings saga will be.
  2. Getting the many consents needed to build and run such a plant in a capacity-constrained economy.
  3. Overcoming the potential issue that better returns for suppliers of the necessary capital to build and run such a factory could come from investing in current construction techniques instead.

Nonetheless, the Minister should be congratulated for starting to push the boundaries of what we are used to as he tries to improve housing supply. In similar vein the planned easing of regulations facing construction firms bringing in foreign staff is a good idea. How many will come here over what timeframe however is very uncertain. It is not just the house building companies facing resource shortages but the suppliers of building materials and services as well. There is little use in a building business bringing in more carpenters if they cannot be sure of a faster supply of concrete and framing. Councils also do not have enough inspectors and consenting officers.

And the other factor to consider is the tightening of credit availability. Just because moves are made to help alleviate one constraint does not mean output naturally will rise if another constraint is equally as binding.

And one more thing to note. We Kiwis tend to think that there is a whole planet of people who want to live here. Not so. There are a lot of other countries most migrants would prefer to live and work in. We also don’t pay all that much by Western world standards. And there is the additional issue that in countries people are probably picturing in the heads right now as sources of skilled carpenters and plumbers, such people are in fact in short supply! That may help explain why our shortage persists even though construction workers are already on the skilled labour list which gives immigration preference to those with such skills.

Sourcing labourers from offshore? No problem. Finding skilled tradespeople? Difficult

Foreign Buyers

During the week ASB economists noted that while data from Statistics NZ suggests a gross 3.3% of dwelling transfers of legal title (not the same as sales) were to foreigners in the March quarter, (net 1.8%) the actual proportion may exceed 11% once the 8% of sales to non-citizens living in NZ is taken into account.

https://stats.govt.nz/news/just-over-3-percent-of-home-transfers-go-to-overseas-buyers

For your guide, the ban on foreign buying would allow these 8% to continue to buy houses if they hold any form of residence visa

“…we recommend amending clause 7(4), replacing section 6(2) of the Act, to provide that all residence class holders who meet the other requirements of that section be considered ordinarily resident in New Zealand.”

https://www.parliament.nz/resource/en-NZ/SCR_78504/8a4060ab0694885da41dbbaa4e800a49e5a88c2b

So the proportion of potential buyers to be taken out of action by the coming ban will be closer to 3% than 11%.

If I were a borrower what would I do?

Over the past few years we have seen a tightening of credit availability in New Zealand with a tendency for rules introduced in Australia to find their way to application here a few months later.

Thinking about this I came across an article this weekend noting that the proportion of total housing lending in Australia which is interest only had fallen to 16%. The proportion a year ago was more than double that. Interest only mortgages now account for 31% of the stock of existing Australian mortgages compared with 39% a year back.

In New Zealand the stock of lending which is interest only sits at 27%. But the proportion of new lending which is interest only sits at 31%. This is down from 33% one year ago and 40% two year’s back. The rate of decline in this measure of lending riskiness has clearly slowed down. It would not be surprising if through back channels we see an instruction to NZ banks from their Aussie parents to kick this ratio lower lest it attract the attention of the Australian regulators who can be thinking nothing other than the necessity for further tightening of lending criteria in light of the banking Royal Commission submissions.

Just a thought with no actual knowledge of such plans to back it up. Note that competition between banks for mortgage business seems quite strong at the moment. We have just cut our one, two and three year fixed home lending rates by 0.1%, 0.06% and 0.06% respectively. This is despite no unusual decline in swap rates which underpin lending rates.

If I were borrowing at the moment I would be even less inclined to fix longer than two years than I have been. That is because downside risks to interest rates are growing as the US-initiated trade war escalates. It is too early as yet for central banks to factor these developing risks into their central forecasts and we saw that this morning as our own central bank reviewed its 1.75% official cash rate.

The rate was again left unchanged at the level it fell to in November 2016. But there were some soft comments in the RB’s statement.

“However, the recent weaker GDP outturn implies marginally more spare capacity in the economy than we anticipated. The Government’s projected spending impulse is also slightly lower and later than anticipated” …

“This (global) outlook has been tempered slightly by trade tensions in some major economies. Ongoing volatility in some emerging market economies continues.”

The RB remains of the opinion that it is just as likely to cut the official cash rate as raise it.

The Weekly Overview is written by Tony Alexander, Chief Economist at the Bank of New Zealand. The views expressed are my own and do not purport to represent the views of the BNZ. This edition has been solely moderated by Tony Alexander. www.tonyalexander.co.nz or www.bnz.co.nz

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