After several months of a solid performance against most major currencies except its biggest trading partner, the New Zealand dollar has finally begun to outperform its Australian counterpart in December. The move came after several months of relative depreciation against the Aussie driven by anticipation of negative rates from the Reserve Bank of New Zealand.
Bets in fixed income markets for negative rates were eased back over the course of October and November, as the sheer scale of the economic success of the Government’s elimination strategy for covid-19 became apparent. With Q3 GDP data showing a roaring economy and the RBNZ under increasing public and political scrutiny for its role in surging house prices, the central bank is now far less likely to need to resort to negative rates. Additional tailwinds for the economy will come from a cyclical global recovery, sustained fiscal stimulus, and superb prospects for a recovery in consumer and business sentiment. For these reasons, we maintain a highly constructive view on the New Zealand dollar in 2021.
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ROCK STAR ECONOMY REDUX
HSBC’s Paul Bloxham famously dubbed New Zealand a “rock star” economy during the mid 2010s, as OECD-leading growth and permissive risk conditions allowed the Kiwi dollar to rally towards parity against its Aussie counterpart. Following the extraordinarily effective response of Jacinda Ardern’s Government to the Covid-19 pandemic, New Zealand’s economy is again inviting such comparisons. The simplest place to begin these comparisons is with growth. Real gross domestic product as measures by Stats NZ fell 11% in the June quarter. Data released this week showed a 14% expansion in the September quarter, the largest on record. Some context and comparison is needed to highlight the significance of these numbers. For starters, the Q3 gross domestic product figure is 0.4% larger than Q3 2019 – the only peer economy for which growth is positive on this basis. Several key peer economies such as the United Kingdom, Canada, and the Euro area, will take multiple quarters or years to recover this output loss, something New Zealand has already accomplished.
New Zealand Q3 Gross Domestic Product Up 0.4% in 2020 compared to 2019
Stats NZ, OECD
The cause of this remarkable performance is straightforward…
Aggressive lockdowns and equally aggressive border closure and quarantine policies have enabled almost all of New Zealand’s economy to reopen in Q3 and Q4, with the exception of the international tourism sector.
The Q2 contraction New Zealand saw as a result of these measures was comparable to other economies that saw broad restrictions of economic activity such as the UK, EU, Canada, and the US. However, relative to the size of the initial shock, the 14% bounce in Q3 was uniquely strong. The lack of community transmission of Covid-19 likely contributed to an enthusiastic recovery in indoor services and hospitality that was not equaled in peer economies. Expenditure on clothing and footwear, for example, was up 7.4% year on year, indicating consumers were willing to release pent-up demand from the lockdown. The net effect was an optimal recovery relative to the size of the initial shock, when compared to other G10 economies.
New Zealand data show G10-leading mix of Q2 shock and Q3 recovery
In the near-term future, the contrast between the New Zealand economy and major peers is likely to remain striking. With much of the UK, US, and most of Europe still either maintaining or intensifying restrictions on economic activity, New Zealand has had no community transmission of Covid-19 since November 18th. Q4 gross domestic product is expected to grow a further 0.8%, according to the consensus of forecasts submitted to Bloomberg. Once again, the contrast with peers is striking, with the UK (-2.4%), US (-2.4%), and Eurozone (-2.2%) expected to see further contraction. Canada and Australia are expected to continue their respective recoveries by the same measure.
The details of Q3’s data and other leading indicators suggest that the outlook for growth is solid both in the short-term and medium-term future. Household consumption rose 14.8% in Q3 after contracting 12.1% in Q2, while fixed asset investment rose 20.7% after falling 19.8% in Q2. Residential investment was boosted by a significant boom in house building and rose an astonishing 42% in Q3, leaving this component of GDP up 7.3% year on year. The strong recovery in consumption and investment bodes well for growth in 2021, which is likely to be weighed down by less “scarring” than in peer economies with longer-lasting restrictions. Similarly, the boom in house prices is likely to transmit to consumer spending – as the RBNZ is well aware.
LESS PRESSURE ON RBNZ FOR NEGATIVE RATES – BUT HOUSE PRICES PRESENT FRESH HEADACHE
The rapid economic recovery currently underway has greatly reduced the likelihood of the RBNZ implementing negative interest rates, but booming house prices now present at least a political challenge for Governor Adrian Orr. November’s meeting saw policy rates and quantitative easing unchanged, and a new, approximately $30bn Funding For Lending program announced. Negative rates, which were previously a topic of serious investigation, seemed to take something of a back seat, although the statement did say they remained under consideration. The central bank said that the economy had “proved more resilient than earlier assumed”, while peak unemployment rate was revised downwards to just 6.4%. Growth in 2021 was forecast at a reasonably optimistic +3.4%, although it is worth noting this forecast was conditioned on the assumption that the international border would reopen in 2022.
Given the latest vaccine developments, risks may be tilted to the upside of this assumption.
Markets pare back bets on negative rates from RBNZ
With the economy recovering and fiscal policy expected to remain simulative through 2021, one might expect the RBNZ to remain on a fairly passive footing. However, surging house prices may be a bigger area of focus for the RBNZ than the wider macro economy or the path of inflation. House prices have risen aggressively this year, in a trend echoed in many developed economies, even those with less robust economic recoveries such as the UK. Data from the Real Estate Institute of New Zealand has shown the median house price across the country has risen by more than $100,000 this year, to reach a record high of $749,000. The price increases have become a matter of intense political and public attention, as has the RBNZ’s involvement through simulative monetary policy. On the 24th of November, Finance Minister Grant Robertson wrote to the Reserve Bank to “seek views” on addressing the issue of rising house prices. Specifically, the Minister asked for feedback on the prospect of amending the Bank’s mandate to consider house prices and seek to avoid “unnecessary instability”. In this context, instability can only be interpreted as undue appreciation. Monetary policy is a poor tool for addressing house prices, as seeking to reduce monetary accommodation for fear of stoking house price gains in the current economic climate would likely mean higher rates, lower growth, and a significantly stronger Kiwi dollar.
House prices surge
Unsurprisingly, in a reply to Robertson, RBNZ Governor Adrian Orr said that the Bank’s preference, if necessary, was to add house prices to its financial stability remit instead of its monetary remit. Much of the letter was taken up with an argument for the other drivers of house prices, notably supply. Orr also argued that adding a house price remind would force painful trade offs where higher housing prices called for higher interest rates, which in turn would harm the rest of the economy and keep inflation below target. In contrast, adding a house price addendum to financial policy would force fewer costly trade-offs such as these.
Looking ahead, the issue is likely to remain politically sensitive, and further changes to either the RBNZ’s policy or mandate are entirely plausible…
For example, Orr’s letter asked the Minister to consider giving the RBNZ the power to implement debt serviceability limits. Even if no further political pressure is applied, the RBNZ is likely to view house price appreciation, at the least, as a reason to err on the side of caution in applying further monetary easing in 2021. Bank has already announced its intention to re-implement loan-to-value restrictions in early 2021, and it seems likely that further measures may be announced, especially if new powers are granted by the Minister of Finance.
FURTHER THOUGHTS ON THE BALANCE OF RISKS
NZD strength is one of our stronger conviction calls for 2021, but one additional downside risk is worth mentioning: The housing market itself presents a longer-term source of potential economic instability, should inflation begin to rise faster than expected over the next 5 years and the RBNZ be forced into a rate-hike cycle. RBNZ data shows New Zealand’s ratio of household debt to disposable income has risen to its highest level on record. This is not inherently concerning given that servicing costs as a percentage of income remain relatively low. However, a sudden inflation spike could change both interest rates and servicing costs.
Author: Ranko Berich, Head of Market Analysis