New Zealand faces an economic hangover in 2023 - we're just not sure how bad it will be yet.
We are, as new BNZ chief economist Mike Jones puts it, “well into the hangover phase of the economic cycle”.
To stretch the metaphor a bit further, we’re awake, we’re feeling queasy and we know we overdid last night - although the details are a bit hazy.
We all know the economy is going to be a bit rough in 2023. But how rough? Things could still go either way from here.
Jones argues, in his research note looking at the year ahead, that given the epic scale of Covid’s impact, pundits have been pleasantly surprised about how well the economy has held up so far.
“We reckon next year will be different. It’s gonna feel different, and not in a good way,” he says.
There’s now a pretty broad consensus about a downturn in 2023, something that was really rammed home to the public by Reserve Bank Governor Adrian Orr in his last Monetary Policy Statement for the year.
Orr and the RBNZ team forecast a relatively shallow but lengthy recession to begin mid-year and carry through into 2024.
Will they be proved correct?
For mortgage holders specifically, but with flow-on effects for everyone, a lot hinges on how high-interest rates go.
So, when we look at the big issues for 2023, it makes sense to start there.
Interest rates
If you’re a mortgage holder and haven’t already done the maths on what you might be paying next year, you could be in shock.
Higher mortgage rates are a near certainty.
For many New Zealanders, 2023 will be the year when they roll off historically low fixed-term interest rates.
RBNZ data released in December showed the average interest rate paid on banks’ stock of fixed mortgage lending was still just 3.89 per cent in October.
The average two-year fixed mortgage rate is now sitting at around seven per cent.
So, a certain amount of financial pain and economic slowdown is already baked into the year ahead.
What we can’t yet be sure of is how high the official cash rate will rise, or how long until it will be at its peak before it can start to come down again.
The Reserve Bank hiked the official cash rate by 75 basis points in November to its current level of 4.25 per cent, but it surprised markets with a forecast that the rate will peak at 5.5 per cent midway through next year.
It had previously forecast an OCR peak of just 4.1 per cent.
Most bank economists have now fallen into line with the higher forecasts, although there is a view that the RBNZ will look to get to the peak sooner than later.
ASB economists expect a 75bp OCR hike in February (to 5 per cent) and a 50bp hike in April (5.50 per cent).
Rate cuts are then pencilled in from the second half of 2024 as the OCR is returned towards neutral levels (closer to 3 per cent).
KiwiBank’s Jarrod Kerr is very clear about the difference between what he expects to see and what he’d like to see.
“We believe we will see a peak in the cash rate at 5.5 per cent in April next year. We would like to see the peak at 5 per cent (or below),” he said.
It is a good point to make. When it comes to forecasts, we should always try to separate what we expect from what we hope for.
What we should wish for in 2023 has never been more complicated.
The higher interest rates rise, the more pain the economy will suffer. But the more pain the economy suffers, the faster inflation should fall.
Hopefully, there is a sweet spot somewhere - a scenario where inflation falls at a steady pace and we can avoid doing serious recessionary damage.
ANZ economists see the OCR peak going even higher - to 5.75 per cent, comprising another 75bp lift in February, with a 50bp hike in April and a final 25bp hike in May.
“That final 25bp hike is a hat-tip to how we see the risks tilted around the RBNZ’s updated forecasts, but if anyone wasn’t sure that economists can’t in fact see six months into the future with any accuracy, the last few years should have clarified that point.”
ANZ chief economist Zollner sees a range of risks to that OCR outlook - in both directions.
In a nutshell, they can be summarised as the risk that inflation is even more persistent than expected.
Or, on the downside, that recession hits faster and harder, squashing inflation but also pushing up unemployment.
But either way, the key to picking the future in 2023 does still seem to be tied to the inflation fight.
Your cost of living
So, what should we expect for inflation in 2023? And what will it mean for your cost of living?
There are a lot of variables, many of which (like oil prices) are well outside our control, so picking the exact numbers on inflation is very difficult.
We know that hiking rates will restrict the money supply, slowing demand so inflation should start to fall. It’s the timing and pace that is anyone’s guess.
For a snapshot of all the local forecasts, the NZ Institute of Economic Research’s pull-together of consensus forecasts is a good place to start.
The good news is the consensus view is that inflation has peaked.
The bad news is that that is expected to average 6.3 per cent in 2023, still historically high and well outside the Reserve Bank target range of 1-3 per cent.
Annual inflation is forecast to moderate to 3.4 per cent in 2024 and ease to 2.2 per cent in 2026.
If global inflation pressure falls, and commodities like oil stay relatively cheap (as has been the trend through December), then it will help ease the pressure.
It might even mean inflation falls faster than currently expected.
But economists see the issue being the persistence of a domestic wage-price spiral that has embedded itself in the local economy and will take time to unwind.
Unfortunately, the harder central banks - here and around the world - have to lean against inflation pressure with higher rates, the more likely we’ll face recession and rising unemployment.
If they overdo the medicine, then inflation might come off much faster than expected, but we might not like the side effects.
It’s worth remembering that it only takes one trading session on Wall Street for everything to change - as it did in 1929 or 1987, and to some extent in 2008.
Don’t lose your job
Everyone seems to agree there is a recession is coming in 2023.
But what does that mean really?
Well, technically it just means people will be doing less in the economy. Spending less, making less and building less.
For many New Zealanders, it may actually bring some relief around capacity constraints in the economy.
You might even find it a bit easier to get a builder or a plumber at short notice.
What makes recessions rough is that employers start downsizing and making staff redundant.
Treasury has now joined the Reserve Bank in forecasting recession next year, and sees unemployment beginning to rise from its current historically low level at 3.3. per cent.
It is tipped to rise to 5.5 per cent in 2024 (the highest rate in a decade), with 51,000 more Kiwis out of work.
Not all economists think it will be that rough. The job market is exceedingly tight, and that is using wages up and adding to inflation pressure.
But it is possible that more open immigration in 2023 might help ease the pressure, with less need for job losses.
As the BNZ’s Mike Jones says: “The labour market remains miles out of whack, with firms’ desire to hire more workers nowhere near satiated by the market’s ability to supply.”
Labour force participation has never been higher, he notes.
“There are a few signs firms’ demand for labour is being reined in a little, although we’re not sure if these are genuine or some firms simply giving up on looking.”
“A lift in migration should help loosen the shackles a little. But we still expect the overall lift in the unemployment rate next year to resemble more of a creep than a jump, and for wage growth to remain brisk.”
In other words, the labour shortages are so acute and unprecedented that it’s hard to know what impact the economic slowdown will have.
Don’t worry about your house price
House prices are expected to keep falling through most of 2023. Treasury has updated its forecasts, and assumed prices will fall a further 15 per cent between September 2022 and December 2024, and only begin to recover in 2025.
REINZ statistics for the year to November showed a national annual house price drop of 12.4 per cent, from $925,999 to $810,000.
Auckland figures looked even worse, having fallen annually by just over 18 per cent, or $235,000.
Bank economists are perhaps not quite as gloomy as Treasury, with most expecting the market to bottom out at between 20 and 25 per cent down from that November 2021 peak.
But they have been getting gloomier.
Westpac economists are expecting a cumulative 21 per cent decline in average house prices from their peak.
“Our forecast assumes that this decline continues through 2023 and into early 2024. However, the risks are towards this price weakness playing out faster than we’ve assumed,” said acting chief economist Michael Gordon.
Economists at ASB revised their forecasts down just before Christmas.
“Based on the quarterly QV index, we expect prices to ease about 25 per cent from their late 2021 peak over the coming years, with the trough coming in mid-2024,” said ASB’s Nathaniel Keall.
“Our outlook sees prices erase a chunk – but not all – of their post-Covid gains. Again, given the high levels of inflation we’ve experienced over the last twelve months (and the likelihood inflation remains somewhat elevated in the near term), that number is likely to remain considerably larger in real terms. The inflation-adjusted decline in house prices is likely to be nearer [to] 40 per cent.”
Pandemics are a terrible way to make money
One of the predictions I made last year, that I’m still happy with, was that all the money pumped into the economy by the RBNZ and Government was going to have to come out.
In other words, wherever wealth was inflated by stimulus - be it house prices, KiwiSaver, cryptocurrencies (or even the cash in your bank account), it will now deflate.
It was never real money.
The base case for my outlook has been that the pandemic did not make the world a richer place. It made it poorer. Covid-19 has been massive a cost on the world’s balance sheet.
What we should hope is that 2023 is a year of normalisation. It’s a year when we balance the ledger and get back to a neutral position from which we can refocus on productivity, wealth creation and investment in the future.
That might not seem much fun.
But we should think about it like an overdue trip to the gym. Focus on the long-term results and the post-workout high.
So, I’ve started this feature with a hangover metaphor and ended at the gym.
But I think that still works. The year ahead will be like going to the gym with a hangover.
With any luck, we’ll feel a lot better by the end.
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