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Macro View - Where the rubber hits the road

After riding the post-lockdown high, Kiwis have come back down to earth, and for every one still doing well, many aren’t, says independent economist Cameron Bagrie.

Our economy has been disproportionately affected by the pandemic, he says, with some sectors including tourism floundering, while others like the residential property market thrive.

Despite this, persistent stimulus and a burgeoning partnership between the Government and the Reserve Bank of New Zealand (RBNZ) continue to underpin our economic stability, paving the way for change as we attempt to stabilise house prices while stimulating other parts of the economy.


New Zealand’s Gross Domestic Product (GDP) fell one percent in the December 2020 quarter, with GDP for the year to December 2020 declining 2.9 percent – one of the largest annual falls ever to be recorded in GDP for New Zealand.

“These results certainly reflect some fading in pent-up demand, while a little giving back following September’s shiny post-lockdown surge was to be expected,” Bagrie says.

“We are also now seeing the rubber now hit the road in terms of the real impact of the hit to our tourism sector et al over summer, supply chain disruption, and difficulty in the movement of goods are increasing issues for many sectors.”

“The availability of labour is also constraining growth, particularly in construction and horticulture as firms can’t access the skills they need and can no longer import them from offshore,” Bagrie explains.

“I expect results for the March quarter will be negative also, but the good news is by the time we talk about it, we are almost out of it, and because there is a tremendous lag, Kiwis shouldn’t beat themselves up about experiencing this recession,” Bagrie says.

Despite a negative projection for the next quarter, New Zealand has done a good job of managing the worst effects of the pandemic, and we are well-positioned when compared to other developed countries.


“The economy is managing okay, but we still face challenges, and that is hardly a firm recipe for inflation,” Bagrie says.

“However, we are now starting to see firmer inflation pressures on some areas as supply disruptions impact, commodity prices increase, wage costs move up, and the economy hits some capacity constraints.”

“Rising long-term interest rates are a sign of markets having a pause for thought on inflation risks,” he adds

“Markets are hedging their bets, no longer is it still the one-sided story where everyone expects inflation will remain low, and there is a consideration towards alternate scenarios with prices rising on the ground,” Bagrie says.


There is consensus that New Zealand’s housing shortage will support rising house prices, and Bagrie agrees, with a disclaimer.

“I think Auckland’s shortage is rapidly evaporating with borders closed restricting demand via less migration and people still heading into the regions.”

“Auckland’s building consents last year were above population growth and another year of that trend will remove the shortage completely, this could make life interesting for the construction sector especially in our biggest city,” he explains.

“It is the regions where I think we have intensifying pressures; Auckland rents are flat-lining and regional rents are rising sharply, this is telling us where the real shortages are,” he says.


Wholesale interest rates have started to nudge up, but does that mean borrowing rates will lift too?

“One usually follows the other but at the moment there is no pressure for banks to lift borrowing rates as well because they still have access to oodles of cheap funding,” Bagrie says.

He is referring to the RBNZ’s initiatives which were aimed at lowering borrowing costs to households and businesses by injecting money into the economy through the $100-billion Large-scale Asset Purchase (LSAP) and the $28-billion Funding for Lending Programs (FLP).

Where the LSAP program allows the RBNZ to purchase up to $100 billion of government bonds from banks in exchange for the creation of money, the FLP allows banks to borrow at the Official Cash Rate (OCR), which is at a record low level of 0.25 percent.

Both of these monetary policy tools are keeping interest rates lower than would otherwise be the case but also involve pushing a lot of money into the economy, a chunk of which we have seen flow through to the residential property market over the last six months.

Bagrie says, if we start to see six-month and one-year deposit rates move, it can be read as a pretty good indication that borrowing rates will start to turn up as well.

“But for now, bank funding costs remain super cheap,” he adds.


Despite news the RBNZ remit now includes a reference to housing, Bagrie says nothing much has changed regarding their official goals of full employment and inflation of two percent.

However, he says there has been a shift in rhetoric from the RBNZ and how this translates over the next few months will be very interesting.

“Rising house prices have supported residential investment, creating wealth and supporting employment, though, it appears too much of a good thing with the Reserve Bank pointing to a speculative element which makes it a financial stability risk,” he says.

“After bringing back loan-to-value ratios (LVRs), the Governor has expressly noted the Reserve Bank has not done enough of what they can do, and doing more appears to be the expectation for the coming months.”

“We also have the Government’s latest suite of housing announcements which included extending the Bright-line Test from five to 10-years, and removing interest deductibility which has enabled investors to offset their expenses against rental income.”

The latter, he says, could have a big impact, as yields will need to be higher to offset the loss of interest deductibility, which means you can’t afford to pay as much for the asset.

“Landlords will try and push up rents but the main impact will be via the impact on cashflow and yields,” he says.

These changes, implemented in conjunction with supply-side measures are some massive changes, and Bagrie expects the property market is in for more over the coming year, as policy-makers attempt to find the optimal level for housing inflation.

We are also due to see the results of consultation between the Government and the RBNZ on interest-only mortgages in June.

“If 40 percent of residential investor debt is on interest-only terms, when those people are required to pay down principal, the situation will change pretty quickly,” Bagrie explains.

Previously LVR changes have had a decent impact on market dynamics and the same would be expected if we get debt-to-income restrictions as well, however, Bagrie says the Government’s two-tiered approach is what we should be watching closely.

Demand is being tempered, but the real issue is what the Government is able to do to boost supply, and the supply of affordable housing in particular.

Bagrie notes that successive governments have kicked the affordability can down the road.

“We are seeing a multi-barrelled approach from the Reserve Bank and the Government on both demand and supply, which is starting to address the issues surrounding the status quo of double-digit rises not being sustainable economically or socially,” he adds.

While expecting prices to dip, Bagrie summarises that if the market was to pull back even modestly, homeowners would still be in a position where their assets are worth considerably more than they were at the end of 2019.

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