Tony Alexander update May 2021

A key determinant of where the New Zealand economy goes is the pace of growth in our main export destinations. If they are doing well we tend to see more tourists come our way (when borders are open), commodity prices tend to go up, and the overall volume of sales of our commodity exports rises as well – subject to the weather permitting good production levels.

In our biggest export destination, China, growth of about 8.5% is commonly expected this year. This arises not because of a successful vaccination rollout, given the low efficacy of the Chinese vaccine, but because outbreaks were brought under control quickly and because the rest of the world’s consumers are spending heavily on many goods made in China.

This is where the problem with container location comes into play. Shops outside of China are struggling to get the goods they have ordered because the containers which would normally have been recycled back to China after being emptied in the past are often still sitting in Western and other countries.

Until this situation changes – perhaps by the end of the year – shoppers can expect continuing shortages of some products and businesses will lack timely delivery of key inputs into their production processes.

The strong growth in China is helping push up prices in particular for New Zealand dairy and forestry products with the result that on average all of our export prices in March were 14% ahead of their levels at the end of 2019.

The United States accounts for just over 10% of our exports and their economy is expected to grow 6.5% this year and 4.5% over 2022. This reflects the strong rollout of vaccines, catch-up spending, continued very low interest rates, surging house prices (up 12% in the past year), and a very strong fiscal stimulus from the Federal government.

Australia takes around 14% of what we export – though mainly manufactured goods – and over the Tasman consumer confidence is at an eleven-year high and business investment intentions a 27-year high. One interesting dynamic there is a surge in house building caused by over 115,000 people signing up to receive a $25,000 grant to assist with getting a new house built.

Already I have received feedback of Kiwis being headhunted to work in the new home sector in Australia as demand for building and outfitting staff is extremely high. This drag of Kiwi tradespeople and labourers across the Tasman will impede the speed of growth in NZ house construction over the next three years, cause some frustrating delays for builders and buyers, and push up overall construction costs.

The UK only takes about 2.5% of what we export. But their outlook has improved tremendously in recent weeks as a result of the rapid vaccine rollout. Hopes are high in government quarters and amongst some exporters for a free trade deal to be signed with the UK soon. But as the media have recently noted, there is the usual pushback by the still inefficient farming sector over there and this means gains to New Zealand’s primary producers when a deal does eventually get penned could be a tad limited.

Will the firm growth overseas propel the NZ economy forward at an especially rapid pace? No, but prospects nonetheless are good. There is a key factor which will limit the speed of recovery here over the next couple of years. Labour is in short supply in New Zealand.

The recently released ANZ Business Outlook Survey tells us that early in April a net 16% of businesses were planning to hire more people over the coming year. This is the highest proportion since 2017 and well above the ten-year average of 5%.

But of greater interest perhaps are these numbers from the NZIER’s Quarterly Survey of Business Opinion. In the March quarter a net 49% of businesses said that they were finding it difficult to source skilled labour. This was above the 37% ten-year average and the highest reading in two years. A net 27% said they are finding unskilled labour difficult to source and that is the highest reading since just before Covid-19 struck and well above the 16% average.

But the really interesting statistic from all of the surveys is this. In the March quarter only a gross 36% of businesses said that the main constraint on their ability to grow is a shortage of customers. This is down from 47% two years ago and well below the 51% ten-year average. In fact, this 36% reading is the lowest since 1974.

Businesses in New Zealand are going to have to make some hard decisions regarding their levels of achievable output given the good demand which is set to strengthen, yet the shortage of people and materials needed to produce their goods and services set to get worse. In fact, the government has stated clearly that when borders properly reopen they will not be issuing as many working visas as
before Covid-19.

So, businesses will be in a position where they must focus on their highest yielding products, and in many cases will be easily able to raise their selling prices if they choose. This is partly where the risk of rising NZ and global inflation comes from for the next three years.

Central banks remain at pains to stress that they intend keeping their official overnight interest rates at current low levels through to 2024. But early signs of inflation are appearing and the markets are highly likely over the coming year to price in monetary policies tightening well before 2024.

In fact in New Zealand market pricing is for the first rise in the 0.25% official cash rate to come before the end of 2022. The Bank of Canada also recently noted that the way the Canadian economy is improving they anticipate meeting the conditions to start raising interest rates from record low levels also before the end of 2022.

Well before floating interest rates rise we can expect to see fixed interest rates going up and this is something just starting to happen in New Zealand. Banks are slowly withdrawing their very low medium to long-term fixed housing rates and this is a process likely to continue for the next 2-3 years.

How high might interest rates go at their peaks? Frankly, we can only guess as to how inflation develops in a post global pandemic environment. But for modelling purposes I am assuming New Zealand’s cash rate rises 2%, with a high scenario of 3% and low (optimistic) scenario of just 1%.

For most borrowers, the best way to approach their interest rate risk management given the high uncertainties around an upwardly shifting rates track, is probably to take a spread of fixed rates from the one to five-year terms.

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By Tony Alexander

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