The two faces of migration
The impact of surging migration is two-sided. On the helpful side, the influx of youthful migrant workers is expanding the labour force and dampening wage pressure. The disinflationary force is especially strong given the tightness in the labour market to begin with. Employers were starved of workers. And our surging migration is helping to satisfy appetites, quickly. The labour market is softening, at a time when the demand for workers is starting to ease. Businesses are more cautious than they were a year ago. But on the other side, more people mean more demand. And signs of an increase in demand are surfacing.
For this reason, we’ve lifted our inflation outlook. Inflation has been above the RBNZ’s 1-3% target band since mid-2021. And it’s going to take some time to get back to the 2% midpoint. We’ve seen headline inflation fall from the 7.3% peak to 5.6%. And we expect it to hit ~4.8% by year end 2023. For inflation to fall from the 7s into the 6s, 5s and now the 4s – that’s quite the psychological shift.
But rapidly decelerating imported inflation is doing most of the leg work. Favourable base effects are still in play with last year’s spike in energy and food prices falling out of annual calculations. Cooling commodity prices are also helping to lower the cost of imports.
The tricky part is getting back to the 2% target midpoint. And it all hinges on domestic inflation – the stickier, demand-driven kind. And with surging migration, the risks are tilted to the upside. Rents in particular are high above pre-Covid levels, and rising. Broader pressure within the housing market will also mean stronger house price growth. And with that, comes the wealth effect. Consumption is weak at present, but would be even weaker if not for a fast-growing population. However, we still forecast the return to 2%, albeit delayed, as the economy continues to cool and the labour market loosens further. We see inflation back within the band by the second half of 2024. That’s about a quarter longer than we had previously forecast. It’s not until 2025 that we see inflation settling at 2%.
Rising migration has also prompted an upgrade to our economic outlook, once again. We have shaved off a few %pts from our previous estimate. We now expect the economy to shrink over the Dec-23 and Mar-24 quarters, totalling a 0.2% contraction (we previously had a contraction of 0.4%). By the simplest of definitions, it is a ‘recession’ and one of even shorter duration and shallower magnitude. But whether or not output runs backwards, make no mistake – the economy is weakening under the weight of the RBNZ’s heavy hand. If we include periods of (effectively) no growth in 2024, then we expect about 12-straight months of soft activity. And given a fast-growing population, it’ll surely ‘feel like’ a recession for the average Joe or Jane on the street. Their slice of the economic pie may well be shrinking.
Tourism remains an upside risk to bear in mind. Despite a solid bounce back from the pandemic, tourism is still not yet where it once was. Current levels in October show tourism sitting at about 80% of pre-Covid levels. At first the full return to pre-Covid levels was hindered by a mix of capacity constraints and waning demand. Now the return of migrants has helped plug employment shortages in the industry and it’s all about weak demand. Though not from everywhere. For the most part, short-term visitor arrivals from Australia, the United States and the UK have returned to pre-Covid levels. But it’s our Chinese tourists, our second largest market after Australia, that are falling short of the mark. Chinese visitor arrival numbers are still down around 70% of pre-Covid (2019) levels. And our tourism sector needs a rebound in Chinese arrivals to get back to full strength. Economic weakness in China is hindering travel demand. But the upside risk remains. A return to full strength tourism could very well see us avoiding our forecasted shallow recession.
Tightness in the labour market is quickly abating. The unemployment rate has moved away from record lows and closer to pre-Covid levels. For now, a migration-induced boost to labour supply is driving a loosening in labour market conditions. But the narrative is beginning to shift. Demand for labour is softening. Firms are no longer hiring with the same gusto. And neither are firms searching for workers with the same desperation. The forecast economic slowdown should also see slack emerge. As consumer demand cools, so too will firms’ demand for labour. If firms are expecting to pump out less output, then an extra pair of hands may prove unnecessary, and indeed too costly.
There’s been a mindset shift among businesses, and employment intentions are weakening. There’s a strong correlation between employment intentions and actual employment growth. It’s only a matter of time before those weaker intentions translate into weaker growth. We are expecting the unemployment rate to continue rising to a peak of 5.3% early in 2025. That’s slightly below our previous forecast, given a stronger economic outlook. However, unemployment is expected to remain elevated for longer. Greater slack in the market however is a must in order to cool down domestic inflation. Wages are often the largest input cost for businesses. And a tight market has seen wage inflation spike, which in turn lit a fire under services inflation.But as capacity in the market builds, wage growth should moderate and flow through to a cooling of domestic price pressures. We see wage growth continuing to decelerate, but at a slower rate than consumer price inflation. We see wage growth outpacing inflation, for the first time since pre-Covid by the second half of 2024. It should be a slow end to the cost of living crisis.
Fortunately, the tight labour market has helped cushion the blow of the housing market downturn. And the surge in migration has led to an earlier-than-expected end to the correction. House prices have fallen back to early-2021 levels, recording a 17% peak (Nov-21)-to-trough (May-23) decline. And there are tentative signs of recovery. Sales activity is picking up, and the number of “days to sell” is reducing. We expect house prices to continue recording gains, but of a relatively modest amount (~6%). The migration boom and the new government’s promise of a reversal to a few property rules (interest deductibility, Brightline test, CCCFA) are significant tailwinds to consider. But the market continues to face the steepest interest rates in 15 years – with risk of lifting further – and a forecast rise in unemployment. Such headwinds will likely cap any house price gains in 2024 (see Special Topic on Housing below).
The influential global outlook
As always, no analysis is complete without looking at the global picture. After all, we’re a small open economy with large exporting industries. A global slowdown, on top of a slowing domestic economy, is going to hurt. Subdued growth is needed to continue taming global inflation.
Global growth is forecast to remain below trend of 3.8%. In 2022 global growth was already at 3.5%, and is expected to come in around 3% for 2023. In 2024, the IMF forecast growth of just 2.9%. And that’s another downward revision. Over the medium term, global growth is set to remain at its lowest level in decades. It’s not pretty. But it’s what’s needed to bring inflation back towards target. Global inflation reached a peak of 10.3% in 2022. That’s since moderated with aggressive monetary policy tightening across most major central banks.
For some, like the US, it’s looking more and more likely that a soft landing may be possible. US inflation has fallen to 3.1%. But still, inflation remains at large. Currently 5.5%, the IMF sees global inflation holding around these levels over 2024. The IMF’s inflation guesstimates are stronger than previous estimates as several economies, including ourselves, have proven more resilient. Supported by strong labour markets, inflation has proven very sticky. As such, keeping rates “higher for longer” has become the mantra for many central banks.
The balance of risks abroad remains tilted to the downside. Our largest trading partner, China, is also our largest vulnerability. Since re-opening from Covid restrictions earlier this year, China has continued to experience faltering growth. Despite policy easing, China’s property and debt crisis has spread its way through to lower investment, high rates of youth unemployment, lower consumption, and even deflation. As such, growth forecasts for China continue to be revised lower, concerning commodity exporters like us. China’s weakness undoubtedly has spill over effects for our trading partner growth. Already, we have seen sharp declines across our commodity prices with waning demand. With around 20% of our growth revolving around exports, there’s potential for huge downside risks.
