8 things that mattered this week

In the political economy this week, business confidence fell, China was forced to ease policy to boost its cooling economy, the New Zealand dollar hit a two year low, the Government eased migration policy, the Reserve Bank should have adopted an easing bias and Winston Peters suggested a housing affordability target that would either require house prices to halve or workers in Auckland to wait 100 years for their living wages to catch up.

1. Interest rates might fall again

The big change in the economic picture this week was the return of talk about an interest rate cut here in New Zealand, despite rates rising in the United States.

The Reserve Bank held the Official Cash Rate at a record low 1.75 percent for a record 11th consecutive time on Thursday and pledged to hold it there for some time. It also said it could just as easily cut next as hike next, which was basically unchanged from its last statement, but the cut part of the guidance was taken more seriously this time.

That's because the economic news here in the last couple of weeks has been soft, with GDP growth below the Reserve Bank's forecast from May and business confidence in June falling to post-election lows for both the wider economy and 'own activity'. What had appeared to be mostly a political reaction in late 2017 now appears to be turning into more of a wintry discontent among business owners, driven by a slump in construction sector confidence, flat house prices in Auckland and uncertainty over some Government policies.

Also, the global picture is more uncertain, thanks to Donald Trump's trade wars with China and Europe and a slowdown in Chinese economic growth. This cooling in China is potentially more important for New Zealand.

China's now-supreme-and-leader-for-life Xi Jingping has been trying to slow down reckless lending by state-owned banks and state-connected shadow banks to state-owned companies and local governments, some of which have been on asset buying binges overseas. Lending growth has cooled and that is naturally slowing growth there, although not dramatically.

In response this week, China's central bank effectively eased monetary policy a bit by reducing the amount of capital banks have to put in reserve and by allowing the renminbi to devalue around two percent to a fresh low against the US dollar. Financial markets in China and in other emerging markets were hit hard over the last week on all the talk of trade wars and because the strengthening US dollar and higher US interest rates make it more difficult for US dollar borrowers in these markets to service their debts.

The bottom line is that there's now a chill in the air of the global economy and also closer to home.

Even in America, which has been the best performing large economy this year, there are increasing signals of a slowdown in growth.

They include a flattening of the yield curve in the United States, which means longer term investors are not confident of rising inflationary pressures and interest rates, in part because short term interest rates have been hiked and may be choking off growth. See a good explanation here from Matt Phillips at the New York Times.

One symptom of all of this talk of lower New Zealand rates and a cooling global economy was a fall in the New Zealand dollar to under 68 USc for the first time in two years.

2. Construction confidence in the dumps

The most surprising aspect here in New Zealand is the crash in confidence, hiring intentions and investment intentions in the commercial construction sector at the height of a boom.

Treasury forecasts there will be $100 billion worth of infrastructure spending over the next 10 years, but many are worried about where the next project will come from, whether they can import and hire more staff and whether they are about to under-price and under-deliver on projects where costs are rising fast. Fletcher Building's huge losses on fixed price contracts in Christchurch and Auckland and its subsequent withdrawal from vertical commercial construction has clearly had a huge impact.

The ANZ survey of business confidence in June was released this week and showed confidence in commercial construction collapsing in the last month from a net five percent expecting improvement to a net 11 percent expecting deterioration.

Credit availability is clearly a factor here too. The effects of the cautionary messages from Reserve Bank here and APRA in Australia should not be under-estimated, along with the paralysing effects of the ongoing Hayne Royal Commission on the leaderships of the big four Australian-owned banks. A net 30.4 percent of respondents in the construction sector expected credit conditions to worsen in the year ahead. The Reserve Bank's ongoing review of capital requirements is no doubt dampening lending appetites, particularly for the riskier large commercial and residential projects.

3. 'Don't worry, you can import them'

The Government clearly had an eye on this weak confidence in the construction sector this week when it abandoned its KiwiBuild visa policy of linking the hiring of migrant builders to the hiring of local apprentices.

Instead, it focused on streamlining the process for importing migrant workers and highlighted the risks of not importing workers to construction costs and KiwiBuild's delivery times. The Government announced a policy aimed at dealing with a shortage of 30,000 workers.

The softening of policy comes weeks after the Government quietly dropped plans to strip work rights from sub-degree level international students and also made it easier for students to work for longer after they have graduated. New temporary migrant and student numbers have actually risen in the last year, although annual net migration has dropped from over 70,000 to around 66,000 in the last six months as previous temporary migrants and working holiday-makers cycle out of the system.

The changes to make it easier to employ construction worker migrants is the third easing of migration settings. The Government has also increased the size of the Registered Seasonal Employer scheme for fruit and grape pickers and MSD declared official labour shortages in the fruit picking regions of Bay of Plenty, Hawkes Bay and Marlborough, which enabled people on holiday visas to stay and work in the orchards and vineyards.

4. No change in fiscal, monetary or migration settings

This was the week the Government clearly gave in to the pressure from employers to loosen the migration settings to maintain confidence and to keep KiwiBuild on track. There was not a peep of protest from New Zealand First.

My view all along is that Prime Minister Jacinda Ardern is an urban liberal who was never comfortable with her predecessor Andrew Little's rhetoric and policies aimed at reducing migration by 20,000 to 30,000 a year. That language was dropped shortly after the election and New Zealand First appears to have accepted the decision not to tighten migration settings.

This decision is also in tune with the Government's wider approach. It has not changed the way monetary or fiscal policy has operated. It is still allowing a high interest rate regime and tight fiscal policy to strangle growth and limit the fall in unemployment. Finance Minister Grant Robertson's decision to stick to National's 20 percent net debt limit is the anchor of Government policy at the moment, stopping it from launching the much bigger infrastructure spending and public service spending needed to cope with very fast population growth over the last five years that is still ongoing.

In my view, the Government should be responding to the slowdown and the weak confidence by using its balance sheet and the currently low inflation and low interest rate situation to deal with the massive infrastructure deficits. That would mean borrowing at least an extra $10 billion over the next two years to kick-start the big public transport projects needed in Auckland.

Transport and Housing Minister Phil Twyford was still talking this week of inventing new balance sheets and borrowing tools to help fund the required infrastructure spending. See more here from BusinessDesk's Sophie Boot on Newsroom Pro. That could take years of policy and legislative work. The Government's balance sheet is there now and able to be used.

5.100,000 extra people lying idle

The same lack of ambition could be said for monetary policy, particularly given there are over 300,000 people either still looking for a job or under-employed, as Statistics New Zealand reported this week.

Underlying inflation is stalled around 1.5 percent and showing no signs of rising. The Reserve Bank is supposed to keep it around two percent over the longer run, but has actively helped to push it lower and keep it there over the last five years. New Governor Adrian Orr has shown no signs of changing that approach. He has left the bank's economic forecasting team in place and his comments so far have not indicated a willingness to push harder on the economy to generate more inflation and lower unemployment.

It must be remembered that one in five part-time workers want to work longer hours and there are still 126,600 people unemployed. Combined with those not officially unemployed but still keen to work, there were 337,600 people deemed under-utilised by Statistics New Zealand.

This number of under-utilised is still around 100,000 people higher than it was in late 2007 when Labour was last in power. Many argued then that Labour and then-Governor Alan Bollard ran the economy too hot with underlying inflation rising to around three percent. However, there seems a middle ground somewhere around the two percent mark that the Reserve Bank should be targeting. That is in its mandate, along with a new target of "supporting maximum sustainable employment."

So far, it has done nothing different to achieve that.

It was also noticeable in this week's statement from the Reserve Bank that it acknowledged, yet again, that the spare capacity in the economy had turned out to be larger than it forecast. It has been under-forecasting spare capacity for the last five years, effectively meaning it has been running monetary policy tighter than it should have been.

"The recent weaker GDP outturn implies marginally more spare capacity in the economy than we anticipated. The Government’s projected spending impulse is also slightly lower and later than anticipated," the Reserve Bank said.

Both of those factors would support a change of approach by the bank towards pushing harder to lift inflation and use up the spare capacity. That would involve signalling the next move is more likely to be cutting rates, followed by rate cuts if the news from overseas and closer to home continues to worsen.

Currently, the bank has a neutral stance. In my view, It should have adopted an easing bias.

Some economists are coming around to the idea of more cuts.

"We think the risk of a rate cut over the remainder of the year is greater than the risk of a hike," BNZ's Nick Smyth said.

"While we think the likelihood of a cut is still low, an escalation in global trade tensions (and associated financial market volatility) or further softness in domestic activity data could see the market shift to pricing rate cuts into the very short end of the curve," he said, although his view is in direct opposition to that of BNZ's Head of Strategy Stephen Toplis.

ANZ's Sharon Zollner also saw growing chances of a cut.

"The RBNZ may express a willingness to see inflation overshoot the target, in order to show their commitment to their inflation objective," Zollner wrote before Thursday's statement.

"There are risks on both sides of the ledger, and downside risks have increased. A negative shock (to the terms of trade, for example) or a more disappointing domestic picture
could put a cut on the table – and this could happen rather quickly should conditions warrant it," she said.

"On the other hand, cost pressures are increasing, and a more buoyant economy could see inflation surprise on the upside (eg should migration not fall as assumed)."

Some economists are focused on the chances of a wage inflation surge in the wake of moves to lift the minimum wage 25 percent to over $20/hour by 2021 and after various pay equity deals for aged care and mental health aides. Strike plans by nurses and IRD and MBIE workers were confirmed this week after talks with their (Government) employers ended without agreements.

The pressure is growing, but wage growth has been consistently weak for almost a decade since the launch of the iPhone and as the globalisation of the workforce continued apace.

6. Winston's wishful thinking on affordability

The risks are growing that Winston Peters' six weeks as acting Prime Minister will turn into a winter of discontent. It has already coincided with a campaign launched this week by various employers' federations demanding the Government drop its employment law tweaks.

Apart from the awful weather and the weakening business confidence, Peters' performances so far are not inspiring confidence.

He stumbled into the debate over housing affordability this week with comments that were either wishful thinking or mathematically impossible in real life.

Peters said he saw a house price to income multiple of five times a single living wage as the appropriate measure, but that it would have to happen without house prices falling.

That would mean people on living wages would have to wait over 100 years to afford a home in Auckland at current wage inflation rates.

Peters' comments implied either a more than halving of house prices nationally to just over $200,000 at the current living wage, or a 70 year wait for living wage earners at current wage inflation rates if prices were to stay flat. Even a doubling of wage inflation would mean a 30 year wait nationally and a 50 year wait in Auckland with flat house prices. It would be over a century in Auckland at current wage inflation rates.

Peters initially said on Monday he saw the Government aiming for a house price to household income multiple of five times income. Initially, he said that meant a couple's income and he did not see house prices falling.

But on Tuesday he said that meant five times a single living wage, which would suggest a house price of just over $200,000 at the current living wage of $20.55/hour or $43,000 per year. The current house price to living wage multiple is 13 times the national median price nationally and 19.8 in Auckland. To achieve that multiple with flat house prices at current levels would imply a single living wage of $112,400 nationally and $170,400 in Auckland.

He said the Government aimed to lift wages to achieve that, without reducing house prices. At current wage inflation rates of around 1.5 percent and with flat house prices, it would take over 70 years for wages to 'catch up' to reduce the multiple to five nationally and over 100 years in Auckland. Even if wage inflation doubled, it would take over 30 years to catch up nationally and 50 years in Auckland.

Phil Twyford later clarified the Government was focused more on the median house price to median household income multiple, which is the measure accepted by the UN and World Bank. The measure used by interest.co.nz's decade-long study of housing affordability, which I helped design, uses a definition of one male median income and half a female median income. At current prices, the multiple is currently 6.33 nationally and 9.2 for the wider Auckland area.

A median multiple shift to five nationally with this definition is more realistic if house prices stayed flat and wages grew 27 percent. Even if wage inflation doubled to 3 percent per annum, that would take eight years nationally. It would take 20 years in Auckland.

7. Kris Faafoi's welcome interventions

One of the more activist ministers is Commerce and Consumer Affairs Kris Faafoi, who warned of regulation areas where consumers could do with some help to fend off rapacious lenders and less-than-generous payments networks. He also fired a shot across the bows of banks on allowing customers to give their own data to bank competitors.

He proposed on Wednesday a tightening money lending regulations that could effectively shut down payday lending and limit unreasonable borrowing fees, aggressive debt collectors and predatory mobile traders (shop trucks).

Meanwhile, Faafoi warned in a speech that he would regulate payments service providers if they hiked the fees they charge retailers.

Faafoi told the Payments NZ conference in Auckland he doesn't want to see more increases in interchange fees or merchant service feeds for credit and debit cards, which he says aren't "in the interests of consumers or the wider economy".

He said he was encouraged by heavyweights Visa and MasterCard dropping the caps for some interchange fees that fell "unfairly" on small retailers and has so far chosen not to regulate, unlike his peers in Australia and Europe.

"However, that option remains very much on the table, particularly if I were to see fees increase again," he said in speech notes.

On Tuesday, he also warned banks and payments sector providers to speed up progress on open banking and payment systems.

8. America's worsening polarisation

Two things happened this week in the world's longest-running large democracy to indicate a further deepening of the divides between Trumpian conservatism and a harder line of liberalism.

Justice Anthony Kennedy, the so-called swing vote on the US Supreme Court, announced he was retiring. That gives US President Donald Trump a chance before November's mid-term elections to appoint a strongly conservative judge to tip the balance on the Court towards conservatism. This New York Times headline says it all: Trump Gets Chance to Influence American Life for Generations Through Supreme Court Pick

Secondly, a Democratic congressman who was tipped to become the party's next leader in the House of Representatives was shockingly ousted in a primary by a 28 year old ormer Bernie Sanders aide called Alexandria Ocasio-Cortez. ( New York Times )

The tenor of public debate and the intense pressure from interests at both ends of the spectrum is increasingly polarising politics in the United States. It is happening elsewhere too as economic and social forces (migrationary waves and widening wealth gaps) push voters to the extremes.