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Economy stressed with inflated price for too much stimulus

The latest forecast published by Infometrics reveals our economy has become stretched to breaking point, with demand pumped to unsustainable levels by monetary and fiscal stimulus over the past two years.

This support for the economy was implemented in the expectation of a major recession caused by Covid, but with supply constraints and disruptions a more persistent outcome from the pandemic, the consequences of excess demand are now becoming all too evident.

Inflation is forecast to peak at 7.6 percent pa this year and to still be outside the Reserve Bank’s 1-3 percent pa target band at the end of 2023, it says.

“The Reserve Bank has failed to meet its inflation mandate and has been too slow to recognise that its emergency monetary policy settings were no longer required,” says Infometrics chief forecaster Gareth Kiernan.

“The irony is that the Bank will now need to take firmer action to try and regain some of its inflation fighting credibility, with the official cash rate set to reach 3.25 percent in 2023. Household budgets are being squeezed considerably by rising mortgage rates and higher living costs.”

Government policy is also exacerbating demand pressures, claims the report. “Despite there being little rationale for further spending increases, growth in government consumption is still accelerating and has reached its fastest rate since the late 1970s.

“Capital expenditure also looks likely to pick-up this year as ‘shovel-ready’ projects and other infrastructure work is progressed. Given the lack of capacity in the economy, these spending programmes risk being gobbled up by price increases rather than achieving the pivotal growth the government is aiming for.

“The high cost of living and unaffordable housing threatens to create a brain drain over the next two years. New Zealand’s house prices have risen 63 percent since June 2017, compared to a 26 percent increase in Australia.”

Higher incomes across the Tasman mean that permanently relocating to Australia is an increasingly attractive option, says the report, particularly for people who are not currently homeowners.

“We expect to see a big increase in the number of people leaving for Australia, or to Europe on their OE,” says Kiernan.

“Population growth will hit a 33-year low of 0.3 percent pa this year and stay below one percent pa until mid-2025. Government immigration policy will also keep arrival numbers relatively subdued, providing little relief for businesses struggling to find staff.”

With the unemployment rate is predicted to stay below 3.5 percent throughout 2022 and 2023, workers will be in a strong position to demand larger wage increases, and wage inflation will hold above five percent pa throughout 2023. The current environment means that businesses will feel more comfortable passing these cost increases on to their customers, threatening to prolong the period of above-average inflation and create a wage-price spiral.

“The less favourable outlook for population growth and interest rates means that the housing party is over,” says the report.

Infometrics forecasts a 5.3 percent decline in house prices this year, with smaller falls persisting through into 2023 and 2024. Auckland’s very high property values make the city more susceptible to a correction than most regions.

“In the context of how far house prices have risen, even a 10 percent reversal isn’t that large,” says Kiernan.

“After allowing for inflation, a 10 percent decline would still leave real house prices more than they were at the end of 2020. This outlook reinforces that there’s no quick fix for New Zealand’s housing affordability crisis.

“There are challenging times ahead for New Zealand. The economy will find it harder, and more expensive, to achieve the 2.1 percent pa growth we expect over the next three years.

“We face some tough choices about our spending priorities as we shift away from emergency Covid supports, and the hard reality of unwinding stimulus begins.”




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