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Better times ahead

Cameron Bagrie | February 2024

Happy new year to you all. 

“We are not as wealthy as we thought we were.” That could have been the title of a recent speech given by Paul Conway, the Chief Economist at Reserve Bank of New Zealand. 

Domestic inflation or what economists call non-tradable inflation, is easing, but the path to lower inflation has been slower than expected. At the same time the economy has been weaker, contracting three out of the last four quarters and shrinking 3.1% in the year when adjusted for population growth.   

According to Conway: “Yes, lower gross domestic product (GDP) indicates weaker demand, but also that the productive capacity of the economy was lower than previously assumed.” 

Thankfully that technical jargon has not impacted our bank balances.  

So, what does productive capacity mean? 

The productive capacity of the economy is one of those mystical concepts 

More simply, it’s the money line, or the line that determines living standards. It’s the line we are converging to in the battle to contain inflation. The hope is that we can lift this line. We need a ruthless obsession to increase it. There’s certainly a lot of “hope” in recent business confidence surveys which points to better times ahead. 

Lifting the productive capacity line would allow more scope for demand to lift, people to spend and still see inflation pressures ease. The government is talking a big game but shifting this line will take time. The roading network for example, will not fix itself overnight. 

What can we take from that economic equation?    

Getting inflation down will see continued pressure on business margins as consumers resist paying more. You do not break the back of inflation by allowing a spiral of cost increases being passed on to consumers. That embeds inflation and does not break it. More productive firms, those that embrace technology, or that work collegially across supply chains to streamline costs, will be able to protect margins better.  

The path to lower domestic inflation pressures involves the economy underperforming again in 2024. Some sectors will do better than others such as health, based on the increased demand. Businesses that contribute to reducing our infrastructure deficits and those related to supporting our ageing population should also do well. However, you don’t eliminate inflation unless there are financial pressures. So, 2024 is not going to be a stellar year. Plan accordingly. The real mortgage pain is only starting.  

Central bank’s face a delicate balancing act. They need to keep interest rates high enough to deliver the tough times and low inflation.  But interest rates work with a long lag, and current levels will impact the economy for another 18 months.  Financial markets are anticipating interest rate relief in 2024 and 2025 where monetary policy moves to a less restrictive stance. That is not low interest rates, but interest rates less high. There is a difference between the two. 

The population is still growing. It rose around 130,000 in the 12 months ended September 2023. That provides a base to demand. 

Per capita spending (population adjusted) will likely fall again in 2024. Household’s will prioritise essentials over discretionary items, but the line between the two is often not clear. Alternate solutions might help. Equity release products, for example, could help people aged 65 plus maintain their insurance. Household’s hold $2.3 trillion of wealth. For some, it might be time to consume out of wealth to maintain living standards. 

When the macroeconomic picture is uncertain and hardly stellar, we will see who the really good businesses are. The focus needs to be on microeconomics, which is what firms and leaders do within their economic zone. Focus on it and market share.  

If we want better living standards, that starts with a better economic base our wellbeing is built upon. Better government policy that delivers results would help, but businesses cannot continue to point the finger at government. They need to adapt, invest, and deliver too. New Zealand lags other countries in the digital space.   

Volatility and change is the new normal. We need to be more alert to managing risks.  

Consider the following: 

  • Geopolitical tension and global fragmentation continues, the latest being ships being diverted from the Red Sea around the Cape of Good Hope.  
  • The US election and what it could deliver. Americans could want to move here.  
  • China is facing tough times, and these tough times are impacting New Zealand’s export sector. India offers huge potential though.  
  • Governments around the globe cannot continue to borrow and spend but still need to invest. The right decisions are being plagued by populism.   
  • The COVID-19 pandemic has sped up the need for digital transformation.  
  • Artificial intelligence opens vast possibilities. 
  • When will New Zealand wake up and embrace the opportunities an abundance of water provides?  
  • We cannot shy away from the need to reduce greenhouse gas emissions.   
  • The population is ageing and ethnic mix shifting. 

We need unity and New Zealand is divided. A divided society is economically unhealthy. The new government needs to unite and not divide. That will not be easy. Expect to see disruption.   

The final word 
Reality seems to be sinking in that this is not your normal economic cycle where you stop for a cup-of-tea and better times return after 18 months. Education for example, is getting a lot more airtime. The same with healthcare and infrastructure deficiencies.  

Leadership on many issues will need to come from Wellington, but businesses and households should never rely on bureaucrats. It’s time to get on with it.