ASB economists assess the key risks in the year ahead - there's plenty

ASB economists say the key risk for this year revolves around whether NZ and global inflation will continue to subside and settle at historically low levels.

In ASB's Economic Weekly, senior economist Mark Smith the subsiding of inflation remains a major unknown, "but markets seem to be more confident that it is ‘Mission Accomplished’ for central banks, with policy interest rate cuts expected to start from the middle of this year".

ASB is forecasting that the Reserve Bank (RBNZ) will start cutting the Official Cash Rate (OCR), currently at 5.5%, in August of this year.

Wholesale interest rate markets are currently pretty much pricing in the a first OCR cut as early as May 2024.

Smith says it’s early days, but 2024 could be just as unpredictable and volatile as last year, with plenty of twists and turns to come.

Until some of these key risks crystallise it’s back to watching the data, he says.

Smith's comments follow his earlier release of a Key Risks for 2024 Economic Note, which outlines five key risks for this year.

"Markets remain hyper-sensitive to inflation prints, with cooling inflation readings in NZ and offshore from late last year driving falls in local and global wholesale interest rates and a bounce in global equities. The start of this year has seen a reversal of sorts, but markets, analysts and the RBNZwill be keenly awaiting Q4 [December quarter] NZ CPI [inflation] data on January 24. Prior to then there is plenty of data."

Smith says inflation is falling but the battle is not yet won.

"Absent a global meltdown, OCR cuts before the second half of 2024 look extremely unlikely, with the real risk cuts could be delayed till 2025 if core inflation readings prove to be stubbornly persistent. As such, market celebrations could prove to be a tad premature."

In his earlier 'key risks' note, Smith said cooling rates of tradable [imported] inflation are expected to "moderate the overall NZ inflation pulse".

"But there is no guarantee that the covid-19 premium will continue to unwind. The more persistent inflation measures - core/non-tradable [domestic] inflation - have not cooled to the same degree. Growing spare capacity in the labour market and easing surveyed inflation expectations should see these rates continue to recede but we remain extremely nervous on the outlook.

ASB expects concerted cooling in more persistent inflation measures to be evident over H1 2024, but still see a strong chance of inflation failing to sufficiently cool, which in turn could mean OCR cuts delayed until 2025.

The below are the five key risks outlined by ASB:

1. Inflation persistence. Will global and NZ inflation continue to ease back to historically low levels, or will inflation rates hold up for longer?

2. NZ fiscal policy. Will NZ fiscal policy objectives be met without igniting inflation, further delaying the return to surplus, or keeping the account deficit elevated?

3. NZ population growth. Will record net immigration rates continue and what will be the economic, labour market, and housing market impacts?

4. NZ housing market. Will strong population tailwinds or stretched affordability and debt servicing/rising unemployment headwinds dominate?

5. Geopolitics. 2024 will be a huge year as half of the globe goes to the polls at a time of heightened geopolitical tensions and where social cohesion shows signs of fraying.

Regarding migration, the ASB economists estimate that NZ’s resident population increased by close to 3% over 2023, its highest growth in decades, "with the close to 150,000 person increase larger than the city of Dunedin". Record net permanent and long-term (PLT) net immigration likely contributed more than 80% of this population increase.

ASB expects NZ resident population growth to slow heading into 2025 driven by a concerted cooling in net immigration (from around 130k in the 2023 year to approximately 80k at the end of 2024 and 45k by the end of 2025).

But Smith adds: "Risks are tilted towards net inflows holding up for longer, with widespread implications."

On house prices, ASB expects these to rise 7-10% over 2024, but for it to take until mid-2025 to surpass 2021 record peaks.

"It will take much longer for new inflation adjusted peaks to be reached. We are closely watching borrowing costs, the labour market outlook, migration, dwelling rents, government policy, construction sector activity and inflation, and residential section prices," Smith says.

He says politics will also impact the economic, social and market narrative with the May 2024 NZ Budget eagerly awaited.

"The return to fiscal surplus is imperative to narrow NZ’s huge current account deficit. Fiscal buffers also need to be restored given longer-term challenges posed by population ageing and climate change. Otherwise, NZ runs the risk of credit downgrades that could raise the cost of funds and weaken the NZD."