Economic Overview - mixed blessings

The latest Westpac Economic Overview finds that there has been a palpable shift in the mood around New Zealand. Businesses have been buoyed by the resilience of the economy, and a sudden lift in inflation has financial markets asking if the Reserve Bank might increase interest rates.

The main message from the Overview is that ‘one swallow does not a summer make’. The Covid shock to the economy is not over yet; the inflation spike is probably temporary, and Westpac’s economists do not expect the Reserve Bank will lift interest rates before 2024.

‘In this quarter’s Overview, we have reached some surprising conclusions,’ says Dominick Stephens, Westpac’s Chief Economist. ‘GDP may have been strong recently, but we think the “summer without tourists” will cause a decline of 0.7% over the six months to March. 

‘We estimate that disruptions to global supply chains will cause inflation to spike to 2.5% by June this year, but that it will drop all the way back to 0.8% by June 2022. That’s partly because supply chains will normalise and partly because we anticipate a big lift in the exchange rate, to 78 cents against the USD. Finally, we point out that the housing shortages that have long dogged New Zealand are now rapidly receding thanks to booming construction activity.’

The big constant is house prices. ‘Every Economic Overview since August 2019 has warned that low mortgage rates would lead to rapid house price increases (although in the May 2020 edition we wrongly predicted that Covid would first cause a temporary price decline). Our thinking has not changed, and we are now forecasting 17% house price inflation in 2021. But by the same logic, we continue to warn that when interest rates do eventually rise, house prices will fall.’

Below are the highlights – download the full Overview here.

The New Zealand economy

Economic activity bounced back sharply after last year’s lockdown, but the absence of international tourism means that growth will be subdued this year. In fact, we think GDP has declined over the summer months. Household spending and a rapid catch-up in homebuilding activity will be the star performers this year. But the wider economic lift-off will have to wait until the border reopens, most likely in 2022.

Global economy

The rapid development and rollout of Covid vaccines is giving the global economy a real shot in the arm. The turnaround in economic fortunes has been rapid and is gaining pace. However, while the economic improvement has been impressive to date, central banks are adamant that monetary stimulus will remain in place until economies have fully recovered. All up, we anticipate that 2021 will mark a major turning point for the global economy. Vaccine rollouts also mean that the Covid economic recession now has a finite life.

House prices

House prices are now screaming higher, with a 9% increase in the last three months of 2020 alone. Our analysis has long shown that financial factors, and in particular interest rates, are by far the biggest driver of house prices. And with mortgage rates at record lows, there is scope for further significant gains in prices. We’re forecasting a further 17% rise in house prices over this year – a very strong pace compared to history, but implicitly a slowdown from the current monthly pace. 

We believe that mortgage rates have reached their lows for this cycle, with long-term interest rates now starting to head higher as global economic sentiment improves. The impact will become greater as the prospect of OCR hikes draws closer; we expect house price inflation to turn negative by 2024.

Inflation

Inflation is set to lift to 2.5% by June this year, but we expect it will fall back to 0.8% in mid-2022. The RBNZ will look through the current spike in inflation, so we think OCR hikes are a long way off. However, with the economy now on firmer footing than previously anticipated, we expect that the RBNZ’s quantitative easing programme will be tapered later this year, and that OCR hikes will begin from early-2024.

Agriculture

If 2020 was the year where New Zealand agriculture proved its resilience, 2021 is shaping up as a year where agriculture cashes in on its strength. Simply put, agricultural prices are solid and rising at the same time as production is firming. However, we expect that this sweet spot will prove short- lived as global food supply will eventually respond, moderating food prices over 2022.

Exchange Rates

The kiwi has found its wings in recent months, rising to a two-year high on a trade-weighted basis early in January. Over the coming year, we expect that the New Zealand dollar will gain further altitude relative to the US dollar and other major currencies. We also expect the kiwi will remain firm relative to the Australian dollar.

The impact on franchising.

While the Overview doesn’t comment specifically on the outlook for franchising and small business, the overall outlook reflects the hugely different levels of confidence across different sectors of the franchise market. 

The latest Franchising Confidence Index published at the same time as Westpac’s Overview found that, while the franchising community was more positive than last year on six out of nine measures, responses varied widely by sector. Building and construction, home improvements and logistics are reporting strong growth, while tourism, retail, hospitality and (perhaps surprisingly) childcare are facing greater challenges.

With record low interest rates looking to continue for some time yet, and the promise of an improving global economy, franchises with good business models in the right sectors look set for continued growth.

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