ANALYSIS: At the start of the Covid-19 pandemic in 2020, we all tried to figure out what the virus would mean for our economies, house prices, interest rates, employment, and so on. Virtually every forecast made at that time proved wrong.
This is best understood by considering no one back then said that the closing of our borders and placing of people in lockdown would result in a 46% rise in average New Zealand house prices and a rise in the unemployment rate from 4% to a peak of 5.3%.
Why were all of our predictions wrong? Because none of us had experience of what usually happens in modern times during a global pandemic. I emphasised this point from about April 2020 onwards, and then through 2021-23 emphasised that none of us had experience of what usually happens immediately after a global pandemic.
Now we are in a similar situation. None of us has experience of what usually happens in modern times during a tariff war, potential decoupling of the world’s two biggest economies, and diminishing of the United States’ role, reputation, credit-worthiness and stability. We all have to accept that whatever forecasts we make and whatever ones you are reading will almost certainly be wrong.
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Does this mean we are floundering around in a blind manner? No. There are some key things that stick out. First, the high uncertainty about what is going to happen means consumers and businesses around the world will put spending plans on hold. That means weaker growth.
In New Zealand, the weaker growth comes not only from heightened uncertainty but also supply chain disruptions, which crimp our businesses and lifestyles. Weaker growth in the economies taking a large share of New Zealand – China accounts for 27%, the US 13% – will hobble growth in New Zealand, and weaker share markets will impel a negative wealth effect.
Second, there will be upward pressure on consumer prices. This happens because higher tariffs offshore will increase the cost of producing the goods New Zealand imports from countries imposing tariffs, as their business input costs will be increased. Also, the above-mentioned supply chain disruptions we know from pandemic experience will fuel inflation – potentially by quite a bit.
There will, however, be some downward pressure on prices if China diverts products away from the US market at discounted prices. But again, supply chain disturbances may limit that factor here. And there will be some downward pressure on inflation because of weaker growth. But that is where a key danger lies.
Independent economist Tony Alexander: "We all have to accept that whatever forecasts we make and whatever ones you are reading will almost certainly be wrong." Photo / Fiona Goodall
Weaker growth suppresses inflation by removing the easy ability of businesses to pass cost increases into their selling prices. With one measure of business margins already at a half-century low this will accentuate the wave of business liquidations still running its way through the country through 2025.
Third, for the moment there is downward pressure on share prices because of heightened global risks. But a new element has now emerged. The US President is attacking the independence of the Federal Reserve Board and seeking a leadership change, which would put low inflation targeting at risk. This is causing escalating concerns in the US bond market and that brings a substantial interest rate risk.
Medium- to long-term borrowing costs around the world are determined with reference to where such rates sit in the US Treasuries market. With new uncertainty about the US inflation outlook and the risk that China chooses to exert extra pressure on the US by selling down some of the 10% of US bonds on issue which it owns, upside risks for global fixed interest rates are becoming dominant.
We have no way of knowing how this deteriorating situation will truly play itself out as the US has become a source of instability in the world economy, financial markets, and global geopolitics. For home buyers in New Zealand, these uncertainties should be recognised when considering the “safe” amount of debt to take on and the wiseness of fixing one’s interest rate for only a very short period of time.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
