Key economic themes to watch in 2022

2021 was a year of upside surprises – not only did headline economic growth outstrip expectations, but there was also surprising strength in job numbers, house prices, consumer spending, exports, interest rates and inflation more generally. The strength in the economy has confounded the inflationary challenges posed by logistics bottlenecks, public health restrictions, and acute labour shortages.

Although I remain optimistic about the outlook for 2022, there is also reason to be cautious. The Omicron outbreak has provided a reminder that Covid and its various mutations can still throw spanners in the works. I hope that border relaxations will see a re-emergence of international tourism and a revival of education from the second half of 2022 to add to the existing economic strength that is already happening domestically. However, I am increasingly learning to expect the unexpected so won’t pin my hopes to any material stimulus from these sectors.

At least we are seeing that Covid restrictions are having a smaller negative effect on the functioning of our economy every time an outbreak occurs. The reality is that we all know the drill – our businesses and households have become better adapted to operating effectively under adverse conditions. This observation has given me the confidence that it would take something other than another Covid outbreak to completely derail what’s happening at present in the New Zealand economy.

With this in mind, here are some of the key themes that I will be watching in 2022:

  • Inflation – I expect inflation to rise further in the early stages of 2022. Not only do cost pressures remain acute for businesses across a range of sectors, but inflationary expectations have risen significantly. Businesses will lift prices to protect their margins heartened by the fact that demand conditions remain relatively strong. Although supply-side inflationary drivers will eventually dissipate as global supply chains recover, it may take a little longer to rein back in inflationary expectations.
  • Labour market – Growth in average salaries hit a 20 year high of 7.6%pa in the November 2021 year, while unemployment is at a record low of 3.4%. Business surveys show that hiring intentions remain strong and that challenges in finding workers persist across all sectors and skills levels. Against this backdrop, expect there to be strong growth in wages in 2022 as employees gain the upper hand in wage bargaining. Border re-openings will enable some sectors to access foreign workers, but could also cause challenges for others as pent-up demand for overseas experiences see some youth spread their wings and leave New Zealand. In response to labour shortages, businesses in some sectors may increase their investment in automation and other labour-saving technologies.
  • Interest rates – Interest rates are likely to have further rises as markets price in higher expectations for inflation and the Reserve Bank lifts the official cash rate. We saw fixed mortgage rates rise by as much as 200 basis points across some maturities last year, and given the Reserve Bank’s signalled trajectory there could be another 100 to 200 basis points of increases to come. Over 60% of homeowners will need to refix their mortgage in the next 12 months – and instead of finding mortgage rates sitting close to 2%pa as they did in the first half of last year, people could be staring down the barrel of refixing at 4% to 5%pa+ mortgage rates by year’s end. I addressed the effects which this could have on household discretionary income in a blog post late last year.
  • Housing – House prices on balance are likely to have a more subdued 2022 than 2021. From a demand perspective, not only will buyers be less able to spend as much because of higher mortgage rates and tighter loan-to-value restrictions, but the ability of some households to access credit will be further constrained by new rules under the Credit Contracts and Consumer Finance Act (CCCFA) which make lenders look more closely at people’s spending patterns. The removal of interest tax deductibility for investors will also dampen demand and could lead to an increase in real estate listings from the middle of the year when investors receive their first tax bill without full deductibility. From a supply-side perspective, there has also been a huge increase in homebuilding, at a time when population growth has been subdued. All these factors remove upside prospects for house prices in many parts of the country, and raise the risk of a market correction (although anything other than a modest correction would need other negative surprises to also weigh on homebuyers’ confidence).
  • Regional migration – People from Auckland and some of our other big cities will continue to move into the regions. Covid-19 has been a wake-up call for many and given us time to reflect on what matters in life. The allure of the ‘good life’ pulls people into our regions. Over the past year, the employment pendulum has also clearly swung in the regions’ favour. Not only has job growth been strongest in regional New Zealand off the back of good returns in the primary sector, but the extensive field testing of working from home during lockdowns has finally broken conservative attitudes to remote working. Even as life begins to slowly get back to normal as we put the pandemic behind us, it is hard to see the rekindled love affair with regional New Zealand going away anytime soon. The legacy of Covid may see some permanent changes to the way we work, what we value in life, and where we choose to live.
  • Exports – Most growers and farmers can expect to receive strong prices for their goods in international markets. Not only are milk prices anticipated to hit a record level during the current season, but meat prices are also at record levels, while horticultural returns remain at a high level. Although global shipping costs remain high, they have moderated recently and many of our major exporters have found ways of getting goods to market, including chartering vessels in some cases. But these positives may be tempered somewhat by dry conditions constraining production volumes over the coming months, particularly for dairy farmers. Furthermore, there are some concerns regarding economic growth prospects for some of our key export markets, even though demand for New Zealand’s agricultural exports appears well-supported because our food products are viewed as being nutritious and the majority are staples bought for home consumption (rather than used in restaurant trade).

The upshot for the economy

All things considered, it’s likely that headline GDP (economic) growth will rebound strongly during the first quarter of 2022 following the Delta outbreak of the second half of 2021. How could it not when we have opened ourselves up again and enjoyed a summer where people could freely work, spend, and play?

But we also shouldn’t be fooled into thinking everything is roses either. For the time being, the New Zealand economy is stuck in overdrive in a situation where it is running above capacity. We are busier than is sustainable given our current availability of labour, and business and infrastructure capacity, which means there is still further upside to play for inflation and interest rates. Make no mistake as well that Covid will also remain a headwind for our economy. These factors could yet challenge the resilience of household spending and business investment, even if my overall expectation is one of cautious optimism for 2022.