We're Growing In Confidence. But We've Just Been Reminded Of The World In Which We Live

Businesses are feeling upbeat about the economy. Renewed optimism, however, was built on our ability to keep covid at bay. We're on tenterhooks.

Inflation in the last quarter proved much stronger than expected. Strong demand and severe supply constraints drove prices higher.

The risks of further rates cuts have dissipated. We now expect the RBNZ to keep the OCR unchanged at 0.25%. But more needs to be done to rein in the housing market. And it's a job for the Govt.

Here’s our take on current events
 

We're all on tenterhooks this morning, awaiting updates on the latest covid community case. A woman has tested positive after leaving managed isolation. 28 businesses have been contacted, with times and dates they had been visited. The good news is we've witnessed the efficiency of the Covid tracer app. And the woman's two closest contacts, her husband and hairdresser, have negative test results.

We've gone two months without covid in the community. Our ability to keep the virus at the border has given households the confidence to move freely, in turn helping businesses to stay open. A lift in business optimism was evident in NZIER's latest business survey. Fewer firms expect economic conditions to deteriorate, and more are expecting activity to remain strong. But much of this renewed optimism was founded on our covid management. The latest case is a reminder of the world in which we live. We're all hoping there are no clusters forming. Because clusters mean lockdowns. And our vaccines are still in transit.

Inflation proved much stronger than expected in the final quarter of 2020. The headline print was well above consensus at 0.5%, leaving annual inflation unchanged at 1.4% (details here ). A rapid recovery in domestic demand and severe supply constraints drove prices higher. Non-tradables, the domestically generated inflation, was much stronger than anticipated at 2.8%yoy. And tradables, the imported inflation, didn't fall as much, down 0.3%yoy. Price pressures due to supply issues were at play. But looking ahead, these cost pressures will dissipate. Inflation should ease slightly, before strengthening into 2022.

The resilient economy suggests there is less spare capacity. All inflation measures, no matter how you slice or dice the data, were stronger, and justify a change in RBNZ call.

The RBNZ's dual mandates are far from being met. But the rampant run in the housing market has surely taken a negative cash rate off the table. We now expect the OCR to be left unchanged, well into 2022. Market traders had placed bets on further rate cuts following the RBNZ's rhetoric last year. Now, market pricing of further rate cuts has effectively been removed and wholesale rates have been shunted higher. The Kiwi dollar has surged, with New Zealand's outperformance on the global stage. Thoughts of further RBNZ easing have turned to thoughts of RBNZ tightening via macro-prudential policy.

In our opinion, the next best step the RBNZ could take is a reassessment, and bank repricing, of the risk associated with home loans. The risk weighting on home loans could be adjusted, to better reflect the higher risk associated with interest-only and investor loans. Applying a higher risk-weighting on investor mortgages, forces banks to hold more capital against those loans, and ultimately price them differently. Someone walking into a bank with a 30% deposit, to upgrade their home, should receive a lower interest rate than a leveraged investor buying their 5th investment property on interest only.

Of course, any tweaks to mortgage rates won't fix the housing problem, not even close. Attacking demand is not the answer. Fuelling supply is the answer. And fuelling supply is more a fiscal responsibility. The Government must step up, in support of the councils, to unlock land, build the infrastructure, and provide long-term plans to tackle our chronic housing shortage. A multi-pronged approach that provides certainty is needed to channel resources into housing development. We've heard the excuses. We know the solutions.

We need to put our foot on the shove al-ready.