Quarterly economic update

After recovering strongly from the COVID-driven falls of 2020, the markets have had a bumpy start to 2022, with the NZX 50 falling 7.2% across January and February.

While global markets recorded strong economic growth in 2021, forward-looking indicators began to slow late last year. This happened as businesses and consumers became increasingly concerned with the continued impact of higher supply chain costs and inflation. More recently, investors have been understandably heavily concerned with the geopolitical implications of Russia’s invasion of Ukraine.  

On a more positive note, the New Zealand economy remains remarkably resilient as unemployment continues to fall, commodity exports hit record highs and retail sales rebound.

Here are the key trends to watch over the months ahead.

Ukraine and the energy price surge

As Russia launched an invasion of Ukraine in February, oil prices skyrocketed to near seven-year highs, approaching US$120 a barrel.

While energy prices were already surging prior to the Ukraine crisis, Russia is the world’s second largest oil producer and a major natural gas provider for Europe. Interruptions to supplies we are expecting higher prices at the pump for consumers worldwide in the near term. The potential for disruption is significant – a worst-case outcome could see the cost of oil rising to US$150 a barrel, reducing economic growth by over three quarters and more than doubling inflation across the globe.¹

For New Zealand, escalating tensions may also impact demand for export commodities, although key export commodity prices could still hold firm.2 If livestock feed prices rise, this may give New Zealand’s grass-fed dairy and meat producers a cost advantage over grain-fed competitors.

Inflation and interest rates

Meanwhile, inflationary pressures have been growing around the world. New Zealand’s inflation hit 5.9% over the year to December 2021 – the highest rate in more than 30 years – which has exceeded expectations. While it hasn’t reached the heights of the US (7.5%)³, New Zealand’s inflation has been running above that of Australia (3.5%)⁴ and even the UK (5.5%)⁵ and Europe (5.1%).⁶

The Reserve Bank of New Zealand (RBNZ) has an inflation target range of 1–3%, which is lower than both Australia and the US. This has been a factor in it being one of the first central banks to begin the path of increasing interest rates back to more normalised levels post-COVID. The RBNZ has so far initiated three interest rate hikes between October 2021 and February 2022, bringing the Official Cash Rate (OCR) from 0.25% to 1%.⁷ The RBNZ is forecasting the OCR will revert to 3% in the coming years. 

Despite recent market volatility arising from Russia’s invasion of Ukraine, the high Consumer Price Index (CPI) data has resulted in the US Federal Reserve beginning its rate hike cycle in March. The markets had already been gearing up for around five rate hikes in the US this year; however, expectations have slightly softened as of late with the Ukraine crisis.

Along with the Reserve Bank of Australia, the Federal Reserve has already ended its quantitative easing (QE) program which it implemented during the COVID crisis to ensure cheap liquidity to markets.  We expect the central banks will unwind these bonds purchased from their balance sheets over time by rolling off the bonds each month as they mature, rather than selling the bonds back to the market.

Even though interest rates are starting from a very low point, rate rises impact consumer spending and the housing market. Consumer confidence indices around the globe have already softened significantly with expectations of rate hikes this year. A combination of high inflation and rising mortgage interest rates will erode the purchasing power of consumers and soften household spending.

Wages and supply chain pressures

Potential interest rate rises are not the only challenge for businesses and investors. With the Omicron wave still sweeping through New Zealand, the effects of the variant can be felt across supply chains and distribution networks. This is resulting in shortages of both materials and finished goods. These disruptions are expected to continue throughout 2022 – delaying business activities and pushing up operating costs in some sectors.⁸

Wage increases have been more moderate than expected, lifting 0.7% in the December 2021 quarter to reach an annual wage growth of 2.8%.⁹ The surge in Omicron cases in New Zealand could affect the supply of labour in the coming months, tightening the labour market further and causing wage inflation to accelerate.

However, Prime Minister Jacinda Ardern announced a phased border reopening plan in February, which would alleviate current labour shortages and reduce local supply chain and wage-related pressures.

Economic recovery from COVID

Despite these headwinds, developed economies bounced back strongly over the year to December 2021, with GDP growth of 7% in the US¹⁰ and 5.2% in the Euro region.¹¹ New Zealand reported strong GDP growth of 4.9% in the year to September 2021,¹² though growth expectations for the future may be softening.

In the final quarter, the New Zealand unemployment rate fell to 3.2% and is on track to drop to just 3% over the coming months.¹³ While annual growth in employment slowed to 3.7%, this remains well above the rate of growth in the labour market – 1.9% year-on-year.¹⁴

The December quarter also saw a post-lockdown rebound in retail volumes, ending 2021 just 0.3% shy of record highs. Retail trade spending volumes rose 8.6% in Q4, above market expectations.  We expect developments in the Omicron outbreak to be an influence on retail activity in early 2022.

Prices for commodity exports have also jumped by 24% to hit record highs. Strong global dairy prices are leading the way – and the lift in earnings is boosting farm incomes along with spending in regional communities.¹⁵

What it means for markets

While we expected economic growth to slow as the impact of central bank tightening kicks in, the economy should hopefully benefit from an easing in COVID-related supply disruptions during the latter part of 2022.

Given softer growth expectations, one of the big questions for markets is whether the economy can absorb further rate hikes this year.

Global share markets have already had a bumpy start to 2022. The growing geopolitical tensions with Russia are an increasing left tail risk. The expectation of higher interest rates has already seen the beginnings of a shift away from high-growth stocks and the US mega cap technology sector – both of which have performed strongly in recent years – in favour of ‘value’ stocks.

Bond yields have also shifted higher with interest rate expectations resulting in negative returns for fixed interest investors. This has created challenges for multi-sector investors seeking diversification.

Overall, we are expecting investment returns to soften in 2022 after the strong gains of the last 20 months.

^{1 S Kennedy, ‘JP Morgan War-Games Economic Damage of an Oil Serge to $150’ Bloomberg, 22 January 2022, accessed 2 March 2022.
2 ASB, Economic Weekly, 28 February 2022, accessed 3 March 2022.
3 R Pickert, ‘U.S. Inflation Charges Higher with Larger than Forecast Gain’, Bloomberg, 11 February 2022, accessed 2 March 2022.
4 Australian Bureau of Statistics, ‘Price indexes and inflation’, 25 January 2022, accessed 2 March 2022.
5 Office for National Statistics, ‘Consumer price inflation, UK January 2022’, n.d., accessed 2 March 2022.
6 Trading Economics, ‘Euro Area Inflation Rate’, February 2022, accessed 2 March 2022.
7 Reserve Bank of New Zealand, ‘Official Cash Rate (OCR) decisions and current rate’, n.d., accessed 1 March 2022.
8 Westpac, ‘Economic Overview – The bill comes due’, February 2022.
9 ASB, ‘Economic Note’, 2 February 2022, accessed 2 March 2022.
10 Trading Economics, ‘United States GDP Growth Rate’, n.d., accessed 2 March 2022.
11 Trading Economics, ‘Euro Area GDP’, n.d, accessed 2 March 2022.
12 Stats NZ, ‘Gross domestic product (GDP)’, 16 December 2021, accessed 2 March 2022.
13 Westpac, ‘Economic Overview – The bill comes due’, February 2022, accessed 2 March 2022.
14 ASB, ‘Economic Note’, 2 February 2022, accessed 2 March 2022.
15 Westpac, ‘Economic Overview – The bill comes due,’ February 2022, accessed 2 March 2022.}