Opinion: Next year is likely to be a ripper for the economy, but just how good? Here is an attempt at some specifics

By David Hargreaves

Well, it’s that time of year when a kind of communicable madness sets in and normally sane people try to work out what will happen in the next 12 months.

Therefore in the spirit of “everybody’s doing it, so why shouldn’t I”, here are some predictions of an economic nature from me for the year ahead. I stress that the forecasts are very much my personal opinions.

For the sake of meaningful comparisons, appended to this are both the latest Reserve Bank Monetary Policy Statement, complete with official forecasts, and the NZ Institute of Economic Research's Consensus Forecasts.

I've indulged myself by putting my specific predictions in bold text, hopefully to make them easier for you to digest. As always your constructive feedback is most welcome. Enjoy.

Death to LVRs

I’ll start with the most “out there” prediction, which is that I pick the Reserve Bank will announce the ending of the hotly-debated “speed limits” on high loan-to-value lending in April.

I pick April because it’s realistically about the earliest the central bank could do it, given that the first assessment of the bank’s lending ratios will be done based on a rolling six month average, starting from October 1.

Why do I think it will be canned? Well, notwithstanding the brave face the RBNZ was trying to put on it last week, the introduction of an exemption for houses under construction was a humiliating defeat and one that will severely undermine the policy.

Worse, of course, it opens up the playing field for others to come along and skillfully lobby/pressure the way the building industry did. And with next year being an election year the Government will be listening to anybody who votes. You could end up with an LVR policy that virtually everybody is exempt from.

My pick is that the RBNZ would not want to let it get to that point. The LVR policy has to date had a sharp impact on market behaviour and the banks have fallen into line. Why wait through next year and watch the policy get more and more diluted as the Government goes into full baby-kissing mode?

If the RBNZ pulls the plug in April (or at least announces the end of LVRs at that time) then it could claim some success. Also it could then holster this particular weapon to be brought out at another time (not an election year).

OCR

Remember also, and catching on to the militaristic theme, the RBNZ will be bringing out its blunderbuss, I would pick (along with most economists) in March and start hiking interest rates. This of course is the weapon of choice when it comes to taking aim at the housing market.

So on that, my pick is for a first rise in the Official Cash Rate, yes in March, followed by a mid-year lull and then some very aggressive tightening – for reasons to be made clear through my range of predictions – in the latter months of the year. I’m picking an OCR of 3.75% by the end of the 2014 calendar year, which would be a whole 125 basis points higher than the 2.5% OCR we have now.

Mortgage rates

At the moment banks’ floating mortgage rates are on average around 5.65%. If you took my OCR pick as gospel and added a straight 125 basis points on to that rate, it would give floating mortgage rates of approaching 7% by the end of next year, which would have to sting a bit.

Realistically, I can’t see that. Competition for mortgage business is fierce and likely to remain so. The margin between the OCR and what banks charge for floating mortgages has tended historically to operate somewhere in the region of 200-300 basis points. At the moment, taking the “effective” floating mortgage rate as in the RBNZ’s statistics sets, the margin is 315 basis points.

Clearly the banks have got some room to trim that. I’ll predict, based on my 3.75% OCR pick that floating mortgage rates will be 6.25% by Christmas 2014.

House prices

Given then that I reckon mortgages are going to be costing quite a bit more, will house values be worth the trouble?

Well, yes, I believe they will. The RBNZ’s expecting house price inflation to peak at around 10% before dropping. But it’s also expecting the LVR measures to knock between 1% and 4% off house price inflation as well. And I don’t think the LVRs will achieve anything like that because in my opinion house prices are being driven more by those seeking houses as investments than they are by those looking for somewhere to live.

So, what to make of it next year? My inclination is to pick house price inflation for the full year of between 10% and 15%, but since that’s quite a large range I’ll go for the midpoint and say 12.5%, which is higher than most would be picking.

Migration

My reasoning combines the neutering of the LVR policy I see occurring, combined with a rush of optimism about the economy and crucially a continued inflow of migrants.

New Zealand’s migration position turned from a net loss to a substantial net gain very quickly. In the year to October 2012 we had a net loss of 2300 people. That reversed to a gain of 17,500 in the year to October 2013.

People rightly point out that a big contributor is the fact that many fewer Kiwis are taking flight across the Tasman, with the Australian economy, for once, looking vulnerable.

But that’s not the whole picture at all. It’s not just about people who are or are not leaving – there’s quite a few coming in as well. In each of the four months up to and including October this year the number of inbound migrants was a record for that month of the year.

Logic suggests that with the New Zealand economy looking rosy, migrants will continue to come and fewer Kiwis will look to leave.

If the normal pattern of high numbers of inbound migrants occurs in January and February then we will be starting to look at historic high net inflows by the end of the first quarter 2014.

The all-time record net inflow of migrants was set in the 12 months to May 2003. I’m going to predict that we will beat that next year. I’ll go for a fresh record of say 44,000 in the year to September-October 2014.

If the numbers do get that high, consider that usually at least half all migrants settle in Auckland, and that gives you another 22,000 people, between them potentially looking to buy several thousand houses in our biggest city. So, I definitely think that come spring next year the pricing pressure on New Zealand’s houses will be only up.

Inflation

If house prices go up, what about other prices? I’m picking inflation of 2.1% by the end of next year. That’s not stratospheric (given the RBNZ’s target is 1% to 3% and the RBNZ Governor is now explicitly targeting the mid-point), but it is higher than the RBNZ’s currently forecasting (1.4%) and I reckon by the end of next year the pressures will be building rapidly.

I think the Christchurch rebuild will inevitably cause bigger price rises both in materials and labour costs than currently hoped, while if Auckland is successful in its efforts to crank up residential building activity in the region, this will put upward pressure on materials and labour costs there too.

And while consumer spending intentions appear very conservative, a little while longer of rising house prices and a generally buoyant economy will loosen the purse strings and that itself will fuel inflation.

GDP

I’ve mentioned a strong economy a bit without quantifying it. My pick for GDP growth for the full year 2014 is 3.8%, which would be pretty heroic. I just think that milk powder will keep working its magic, exports to China will continue to generally go very well, and the boost from construction – not just in Christchurch but Auckland also – will be considerably stronger than currently expected. Oh, and I think consumer spending will start to blip up more than currently predicted too.

Unemployment

Of course, all this economic growth has got to be good for the jobs market. I’ll pick an unemployment rate by the end of next year at 5.1%, (compared with 6.2% as at September 2013). Such a relatively low rate of unemployment will see skill shortages cropping up along with upward pressure on wages – another factor likely to fuel inflation.

The currency

And should anybody want to spend some of their newfound prosperity on an overseas trip, the all important question will be: What’s the dollar going to do? Actually of all the things to predict that’s got to be the most impossible. I’ll go for the Kiwi dollar being worth about 89c against the Australian currency and 79c against the US. But on this one, frankly, who knows?