Liam Dann: Goodbye Covid, now it's time to take our economic medicine

Recession avoided and we've moved past the Omicron wave, but when it comes to the economy, let's not forget we are only halfway through our prescribed dose of medicine. Photo / 123RF

OPINION:

New Zealand passed a major milestone last week as we dropped the last widespread public restrictions aimed at curbing the spread of Covid-19.

Economically, too, we marked the end of the Covid-era with, what should hopefully be, the last set of GDP data that is directly affected by the virus.

Second-quarter GDP showed a big bounce out of the Omicron wave (a 1.7 per cent rise), with returning tourists flying to the rescue and heading recession off at the pass.

Good news, then.

But recession or not, there is no getting around the economic downturn we're facing in the coming months.

Unfortunately, labour shortages and price rises aren't easing with the linear progression of Covid infection rates.

That's because there is still an epic battle at play between forces of inflation and deflation.

And it's a complicated affair because those forces are really all part of the same beast.

When one side gets the upper hand it immediately provides strength to the other.

So, when the US reports higher than expected inflation, markets slump because that means higher interest rates will be needed ... which means the economic slowdown might be deeper, which means commodity prices (including oil) fall, which takes pressure off inflation, which means higher interest rates might not be needed, which makes markets rally ...

And around it goes like some ancient Greek parable that I wasn't quite smart enough to remember and couldn't find in a quick Google search.

What it does mean is that a straight-line recovery really isn't possible.

Lurching two steps forward and one step back is the best we can hope for until, eventually, the global economy falls back into balance.

That does leave us free to take comfort in bad news about the economy slowing down or to worry about it picking up in almost equal measure.

That's something that should keep both tribes of political playground happy - there's certainly no supply shortage of opinion and debate.

That was evident in the major question thrown up by the GDP data last week.

Was it too strong? Did it just point to more inflation risk and the need for the Reserve Bank to push interest rates higher?

ASB and ANZ economists thought so and lifted their forecast peaks for the official cash rate to 4.25 and 4.75 per cent respectively.

But others suggested there was enough economic bad news there to reassure.

Household consumption was off by more than 3 per cent for the quarter, which could give the Reserve Bank some heart that their rate hikes are starting to bite.

Regardless, the RBNZ already had an upbeat 1.8 per cent growth forecast for the quarter - so 1.7 per cent shouldn't trouble its rate outlook.

And in the end, money markets took the data in their stride.

But those of us worried that domestic data is still too strong can take some heart from a new World Bank report that painted a very dark picture of the global outlook in the year ahead.

Even a "moderate hit to the global economy over the next year could tip it into recession", the report said.

A cursory glance at the world news pages is enough to highlight several things that could provide that "moderate hit".

European war, extreme weather and the weird zero-Covid corner that China has backed itself into, all stand out.

A slump in China's economic growth is a serious risk for New Zealand as it would hit commodity export prices hard.

China is doggedly sticking to its zero-Covid policy. Photo / AP

Although, as mentioned above, that would probably be good news for global inflation.

Meanwhile, we'll continue to march the same inflation-fighting policy path as the Americans.

That means more self-inflicted pain from rising rates whatever happens in the world.

The complication there is that - regardless of how hawkish the RBNZ is - we're at all at the mercy of the Americans.

That's because of the global dominance of the US dollar.

When the Fed hikes rates it pushes the US dollar up. Which is good for the US inflation fight - making imports cheaper there.

But it's bad news for all the other countries which see their currencies fall relatively.

Despite an aggressive cycle of rate hikes, the Kiwi dollar dipped below US60c last week.

Some currency analysts see it falling to around US57c in the near future.

That makes the costs of our imports more expensive and works against our inflation fight.

So until America has inflation on the run and the Greenback eases, it is going to be hard work for the rest of the world.

Unfortunately, as well as rampant inflation and recessionary slumps, there's a third risk.

This economic recovery is a balancing act where even too much balance can be a problem.

The World Bank report warns of "generalised stagflation".

That is to say, there is a risk that if policymakers are too cautious everything just stalls with inflation still too high to be comfortable but with growth too weak to drive new wealth creation.

There's a big political element to this because the need for real economic pain to beat inflation runs counter to the cautious approach of incumbent governments.

Voters don't like economic pain. It doesn't matter if they are to the left or the right, no government wants to tip their country into recession.

That's why we have independent central banks - to deliver unpalatable medicine.

So, hooray for skipping recession, hooray for putting the Omicron wave behind us.

But unfortunately, when it comes to the economy, let's not forget we are only halfway through our prescribed dose.