The ghost of inflation past, present and future

Well, here we are at the end of another year, looking forward to a summer of fine weather, sometime relaxing and, as always, sometime pondering the future.  For seven years...

Well, here we are at the end of another year, looking forward to a summer of fine weather, sometime relaxing and, as always, sometime pondering the future.  For seven years or so I wrote a finance and economics column for a community magazine in Auckland and used the December issue to look back at the accuracy of my predictions (or lack of) from a year ago of various economic markers as well make some forecasts for the coming year.  I did the same this time last year for BusinessDesk so let’s take stock of how I fared, while also making some predictions for various economic and market indicators for 2024.  On the surface, I don’t think I would have done particularly well this year as all things from inflation to interest rates to non-USD currencies to asset markets generally turned out to be a bit worse than I and indeed most commentators were predicting.  And here goes with my key predictions for 2024 which, because of the broadly difficult year we have just experienced as well as the confluence of the NZ General Election and Rugby World Cup cycles will hopefully make for interesting reading.

Last year’s bogeyman all around the world of course remained persistent inflation and we were certainly not immune here in New Zealand.  In the latter half of 2021 rising inflation was widely viewed as temporary or transitory.  This view changed quite quickly at the back end of the year and throughout 2022 as economists began to appreciate the horrible inflationary combination of labour and supply shortages, recent monetary and fiscal stimulus and sustained heightened energy prices.  Although the inflation rate might have appeared to peak in the US with the last CPI print in October of 3.2% coming in below both expectations and the numbers of the past few months, prices are still rising remember, which will see the Federal Reserve remain cautious notwithstanding recent comments suggesting the tightening cycle could be close to an end.  Our annual CPI in New Zealand has been pretty steady all year with the latest print being 5.6%. I don’t think it is going to race away from here but neither do I think we’re going to head back in to the targeted 1% to 3% range any time soon – in fact I do predict a sharp decline towards the end of next year – notwithstanding continued near term cost-of-living and wage growth pressures.  So, expect persistent above the range inflation for most of 2024 notwithstanding the macro-outlook which I discuss below.

Of course, high inflation and an environment of both inflationary wage and price expectations can be self-fulfilling which is why the Reserve Bank of New Zealand (RBNZ) has kept increasing the OCR this past year and now oversees a rather high OCR of 5.5% and has warned it may need to go even higher. Our yield curve of course followed the OCR hikes with both short and long rates at levels throughout the year that may earlier have seemed incomprehensible. I think our rates have now peaked as markets have fully priced-in the RBNZ’s hawkishness and the real effect on household activity from the resulting increase in the cost of borrowing or mortgage rates must dampen demand ameliorating to some extent the inflationary pressure.

High inflation and the resulting necessary high interest rates are always and can only be negative for economic activity and its broader measure Gross Domestic Product (or GDP).  Benefitting from benign inflation, low interest rates, healthy exports and high net immigration our “rockstar” economy enjoyed annual real GDP growth of more than 3% for many, many years leading into the awful coronavirus period in 2020, 2021 and even in to 2022. The economy of course contracted while the Government’s stay at home and stay away measures were in place but bounced back in 2021 releasing the hitherto built-up demand.  Our latest GDP growth rate for the year ended 30 June was 3.2% as activity bounced back from the sluggish 2020-22 but is still predicted by many to go negative in 2024 – indeed the RBNZ wants a contraction (and will get it since it determines the level of interest rates) in order to dampen demand and help lower inflation expectations.  My view is that we will have quite a downturn as our small, narrow economy just cannot sustain even current activity levels with labour shortages, wage and consumer price inflation and high and increasing borrowing costs. The recent surge in net immigration – certainly if it continues – may put paid to these GDP predictions though.

Unemployment levels and rates will of course be affected by immigration too..

All of the above is probably good news for house prices.  Peaks in the cost of borrowing, slowing cost of living increases help to steady house prices which have been sluggish over the past year or so.   I see one economist is actually predicting 10% and 15% house price gains over the next two years.

What does all the above mean for the NZ-dollar?  Well, the kiwi has spent most of its post-float life in the mid-60s against the US-dollar only going above or below when things get out of kilter.  We saw low 50s during the GFC (actually bottoming in the 40s…) and high 80s in the early 2010s.  Things certainly got out of kilter in 2021 as the Federal Reserve cranked up its Fed Funds rate and indicated it would keep doing so until the inflation beast was tamed.  This saw a huge rally in the US-dollar and the kiwi slumped to a low of around 56 in October 2021, rally back in to the low 60s since, slump again and now be around the 61 level. I would expect the NZ-dollar to stay here perhaps even soften somewhat if our GDP looks to worsen from current expectations and the resulting inflationary and interest rate outlook eases.  Again, immigration may prove the swing factor.

Share markets will be less driven by a nasty interest rate market (i.e., higher returns from credit instruments driving equities down) It will be a stock-picker’s environment as not all companies will be winners.  Active asset management might come back in to its own.  I’m expecting share markets that have been battered by the great inflation and interest rate reset of the past couple of years will stabilise:  All that bad news is factored in now and/or is in the past.  Any hint that inflation and/or inflation expectations are moderating, and that Central Bankers might take a slower tightening path, will see risk-on markets.  Look for opportunities in listed companies with earnings power and the ability to pass-on costs, defendable business positions or “moats” and as important now as ever, strong, experienced stable management.

The NZ General Election really did prove that a year is a long time in politics.  This time last year Jacinda Ardern was still Prime Minister but polls from back then and in to 2023 saw the centre-right consistently rising at the expense of the incumbents and correctly predicting the change of Government high occurred earlier this month. Some were predicting a landslide which didn’t occur notwithstanding the record collapse in the Labour/Government vote. What made it difficult for the Government in seeking re-election, apart from no leadership, in-fighting and not really having any policies or ideas that resonated with the electorate is the bad economic environment and news flow.  Recall “The economy, stupid” from 1992 Clinton campaign strategist, James Carville.

My most important prediction though from last year was that France would take both the FIFA and Rugby World Cups.  Alas I was wrong on both counts with Argentina and South Africa respectively prevailing.  However not being deterred by this failure and ignoring my own self-advice (stick to what you’re good at) I am happy to confidently predict that Arsenal football club will win the 2023/24 EPL and will even get through to the Champions League final in May.

Happy holidays.