So, 2022. Another year of unwelcome tumult. After all that's transpired, it would be nice to think we could have a 2023 that passes relatively event-free.
But do we really think that’s likely? With everything that has happened since 2020? No, I don't think so either.
The fact is, the past three years have been pretty adventurous – and there’s nothing to suggest 2023 will be any different.
For me the over-arching issue over the next year will be the labour market. How it performs will set the agenda. Which is a very strange thing to have to say.
I simply can't recall a time when the labour market has stood so apart from what else is going on in the economy. Normally a turbulent economic outlook is coupled with jobless numbers rising. So far that just ain't happening at all. What we are seeing is very different to what we are used to. It's a labour market totally defying the economic situation in perhaps an unprecedented way. And definitely a mixed blessing.
We end 2022 with unemployment of just 3.3% (and tipped by the Reserve Bank, the RBNZ, to go even a bit lower yet) and private sector annual hourly wage growth of 8.6%. Our labour market is way too tight, way too hot. Something needs to give. The RBNZ needs to see unemployment start to rise, which will reduce pressure on wages and will have a dampening effect on spending. Such developments would be crucial in reducing inflationary forces.
But will the labour market start to develop some slack quickly enough? I think there must be real doubt. That’s why I’m not optimistic we can tame inflation quickly or easily.
‘Normally’ we could have expected to see unemployment rising by now. There's been few things normal since 2020, however. The jobs squeeze has been exaggerated this time around by the fact that our borders were closed for so long. The ‘normal’ release valve for employers of hiring overseas workers has not been available.
On the one hand, full employment is a blessing. It means that even though interest rates have been rising fast, mortgage holders can meet payments – because they are employed.
On the other hand, because people are employed and able to afford the higher interest rates - maybe they got a nice big pay rise too - the Reserve Bank’s efforts to stamp out inflation (through those aforementioned higher interest rates) are blunted. A full work force means not only that people can meet the mortgages - but they are still prepared to go out and spend as well, thus keeping economic activity hotter than the RBNZ would want.
The RBNZ's forecasting unemployment to rise to 4.8% by the end of the December quarter 2023. I think that looks unlikely.
More realistic, perhaps is that the RBNZ expects wage growth to remain elevated, forecasting an 8% rise in private sector hourly wages for the year to December 2023.
Ultimately, though - one way or another - the RBNZ needs some ‘slack’ to develop in the labour market. But it would want to see signs of this developing pretty early in 2023. If that doesn’t happen then the RBNZ may have to have a rethink on a number of levels. And I think it might need to do so.
If the labour market stays anything like as strong as it is now over the course of the next 12 months then it could change everything, including the inflation picture.
Ah, yes, inflation. The thief in the night that has returned to haunt us. Most people might hold that this is the real 'Enemy Number 1' for the year ahead, but I make it the second most important factor - after the labour market. That's because the labour market will ultimately set the tone for inflation. Everything hinges on the labour market at the moment.
But, okay, Inflation. Let's have a bit of a crunch about the situation we face because it's not quite just as simple as saying, wow, it was at 7.2% as of September, that's too high. (Though of course, that's quite true).
It's worth looking at details, however.
Inflation, remember, comes in two flavours - domestically generated (non-tradeable) inflation and imported (tradeable) inflation.
The RBNZ is hoping and forecasting that tradeable, 'imported', inflation, which has been thrown around by supply chain problems, Putin's war, and by fuel costs - to name just some of the biggest factors - will tail off.
The RBNZ forecasts annual 'tradeable' inflation to be 3.4% for the year to December 2023, down from the 8.1% annual rate seen as at the end of September 2022.
However, the RBNZ reckons our domestically generated inflation is going to be a lot more sticky. It's forecasting the annual 'non-tradeable' inflation to still be as much as 5.7% by the end of 2023, compared with 6.6% as of September 2022.
It is this latter type of inflation, the domestic stuff, that the RBNZ can theoretically do something directly about - through wielding its weapon of choice the Official Cash Rate.
And boy, has it been wielding the OCR. Since October 2021 the OCR has been ramped up from 0.25% to 4.25%. This is an unprecedented rise in such a short space of time.
The RBNZ's forecasting that the OCR may need to go as high as 5.5% by the second half of next year.
Interestingly though, at time of writing the wholesale interest rate markets are not believing that, with market pricing suggesting a peak OCR of somewhat less than 5.5%.
What that market reaction tells you is that the belief 'out there' is that the actions already taken will be enough to cool things down and a peak of 5.5% won't be needed. I'm not sure the markets are reading that correctly.
It comes back to the labour market. If that doesn't play ball (through unemployment rising) the RBNZ may be huffing and puffing till it's blue in the face. And I'm not sure if the 'markets' have quite taken that distinct possibility on board yet.
To switch for a moment to looking at the imported, tradeable inflation, while this is not something the RBNZ can control as such, it could certainly trip up the RBNZ's overall inflation fighting efforts.
You see, the point is, we have over a number of years become accustomed to negligible, or even negative imported inflation. It's just the way things have been. People, we have been spoilt. Globalisation has spoon-fed us.
In recent, pre-pandemic years, the low figures for imported inflation have masked the fact that we've actually had relatively high domestically-generated inflation.
For example, immediately pre-Covid, the annual rate of non-tradeable, domestic, inflation was 3.1% in the December quarter, 2019.
Remember the overall inflation target is for a range between 1% and 3%. So our domestic inflation was actually outside of that.
But it didn't 'matter' as such, because we were importing negligible or negative inflation from overseas.
In fact the annual non-tradeable inflation rate was just 0.1% as of the December quarter 2019, so that was dragging back the domestic inflation. This meant our overall 'headline' CPI inflation figure came in for the 2019 year at just 1.9% - sitting very comfortably in that 1% to 3% range. But really it wasn't that comfortable at all. Figures can be deceptive.
So, we look now to the future and find that, very significantly, and worryingly, the current expectation is for a return to the pre-pandemic pattern, with low levels of imported inflation, but with domestic inflation forecast to stay at elevated levels.
For example, the current RBNZ forecast for three years ahead (as per its November Monetary Policy Statement) is for annual domestically-generated inflation of 3.2% as of December 2025, but for imported, tradeable annual inflation to be just 0.2% at the same time. So, the RBNZ is believing that the pre-Covid pattern of us offsetting domestically generated inflation with little or no inflation imported from offshore will return.
But will this pattern return? I have my doubts. At time of writing the unpredictable Covid situation in China, just to name one thing, is threatening to upset apple carts in the short term. Globalisation as we have known it is surely under threat if not already doomed. And then there's the future ongoing impacts of climate change, which all things equal, are likely to be inflationary.
All of which poses the interesting question: If overseas-generated inflation doesn't turn benign again, what happens?
The fact is, if we don't start importing low inflation again more would have to be done to curb domestic inflation.
Personally, I don't think we can expect things to return to 'as they were before'. At some point we may be forced to look at whether a 1% to 3% inflation target is even feasible anymore. Do we have to 'put up' with some inflation. Can we put up with some inflation? Economic theory says no, we can't. What's the answer if the conventional inflation-fighting approach no longer works?
As 2023 goes on these questions may start becoming more and more pertinent - particularly if inflation is not looking like behaving itself.
There's plenty to think about. And I haven't even started talking yet about migration, houses, the 'Big R' that the RBNZ is apparently engineering for next year and the not-small matter of the looming election.
So, lots more to discuss. And I will. Look out for Part II of this 'year ahead' series - coming to your screen soon.
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