BNZ economist: Chances of recession 'rising by the day'

The chances of getting through this interest rate cycle with a "soft landing" are fading. Photo / Getty Images

"The chances of the New Zealand economy moving into recession are rising by the day," says BNZ head of research Stephen Toplis.

New Zealand's economic "imbalances" were being exposed at a time when the
global economy was increasingly coming under duress, he said.

With the policy measures taken to "fix" these issues getting more and more aggressive the "chance of a soft landing is fading", Toplis wrote in his latest economic outlook report "Recession Bells Are Tolling".

"Our central forecast, currently, is that New Zealand's growth stalls completely in 2023. The danger is that the wheels well and truly fall off."

The fundamental issue New Zealand faced was that the economy has suffered a series of massive supply shocks, he said.

The local pandemic border closures were being compounded by war in Ukraine and ongoing Covid restrictions in China.

Meanwhile a range of stimulus measures had kept demand far stronger than had been anticipated.

"The result of all this is that demand is exceeding supply, the unemployment rate has plummeted to levels that are seen as being well and truly inconsistent with maximum
sustainable employment and CPI inflation has climbed to 30-year highs.

"To cap things off, more recently, the New Zealand dollar has fallen sharply, pushing up tradables goods prices even further," he said.

That was forcing the Reserve Bank to act more aggressively than initially expected.

The New Zealand cash rate has so far been hiked by 125 basis points, taking it from 0.25 per cent to 1.50 per cent.

But we were less than halfway through the process, Toplis said.

"We are expecting a further 50 point increase at the May 25 Monetary Policy Statement followed by a series of rate increases until such time that the cash rate reaches somewhere between 3 per cent and 3.50 per cent," he said.

"This will represent the steepest increase in the cash rate since the Reserve Bank began inflation targeting."

Asset markets were already correcting. Both equity and bond prices were in retreat.

"The last time we had a move in international rates similar to what markets now suggest was 2008," he said.

"So, whichever way you look at it, the planets are aligning in such a way that a recession seems difficult to avoid."

The recession risk would be highest in 2023 when the full impact of rate increases and falling asset prices hit home, he said.

There were however several reasons to have confidence that New Zealand was well placed to handle a recession and that it would be short-lived.

There was such a strong excess demand for labour currently that the first stage in any economic softening would simply ease the excesses rather than drive the unemployment rate higher, Toplis said.

"The peak in the unemployment rate should be lower than in previous recessions," he said.

"The government's coffers are in decent nick so extra fiscal spending can come to the rescue if things begin to look dire."

While there would be fallout from the drop in house prices, the declines had the upside
of helping make housing more affordable.

The banking sector is well capitalised so the risk of a financial meltdown is very low, Toplis noted.

He also expected New Zealand to benefit from a pick up in tourism as international travel accelerated.

"The emergence from all that Covid-19 has thrown at us will provide some tailwind to the economy," he said.

There was still the chance a recession did not eventuate, he said.

"But we think, given the way the world is evolving, households and businesses would do best adopting a prepare for the worst, hope for the best strategy.

"We can say with some certainty that growth can only be moderate at best. If demand constraints don't put a cap on the expansion then supply constraints definitely will."