Recession risk-spotter’s guide: Here’s what could tip us over

Sharply rising unemployment, people falling behind on their mortgages, or softening food prices could be signs a recession is on the horizon, commentators say.

Despite rapidly rising interest rates, falling house prices and high fuel prices, the economy as a whole has so far shrugged off the most dire predictions of downturn.

But economists say there are a number of things that could signal that it is about to change.

household spending

Economist Shamubeel Eaqub says household consumption, at two-thirds of the economy, is a big component.

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“People think [for example] household consumption is only down 1%, no big deal, but when it’s two-thirds of the economy, it’s important.”

A big drop in spending could indicate much tougher times ahead. While the June quarter retail trade survey showed a notable decline, retail card spending rose 1.4% in September compared to the month before, when adjusted for seasonal effects.

“What affects people’s behavior when it comes to spending is typically jobs and incomes – what’s weird this time is that so much income is being eaten up by cost increases, the big increase in the cost of living and interest rates,” Eaqub said.

Economist Tony Alexander said he expected it would take “big layoffs” to create a tipping point into recession. Unemployment remains near record lows.

Incomes are rising, but so too are costs.

stuff

Incomes are rising, but so too are costs.

Infometrics principal economist Brad Olsen said rising interest rates would start to put the heat on some households before long.

“Interest rates are now where test rates were towards the peak of the market,” he said. “It highlights that where people are now is uncomfortable but doable. But any further interest rate rises from here, for those borrowers especially [who bought at the peak of the market] will be incredibly uncomfortable and not necessarily achievable. There’s a risk we do see more people fall over.”

He said there could be a “soft landing” if lending rates made spending uncomfortable, but not to the extent that it could not recover.

“A hard landing comes when you have a snowball effect and a large number of households not able to make their repayments and a longer-term reduction in spending.”

He said he would be watching mortgage arrears, as reported by organizations such as Centrix.

But he did not expect to see large numbers of mortgagee sales. “We learned from the GFC that it’s not in anyone’s best interests to go through with a mortgagee sale. But some of those households in negative equity will be paying substantial amounts of their income in repayments.”

He said unemployment was likely to rise into the next year but it was the pace of that increase that was important.

“A rapid turnaround would lead to the view that a harder-hit recession is inbound. It’s almost the speed of the turn not the turn itself that is most consequential for the economy.”

He said housing had been a major component of how the economy had performed in recent years. “Now it looks equally it will come back to bite us.”

Construction activity can be a sign of the economy's health.

Marty Sharpe/Stuff

Construction activity can be a sign of the economy’s health.

Construction

Eaqub said the construction industry could also provide some insight into the health of the economy.

He said while the residential construction sector was not “that big” it tended to move dramatically.

When the housing market was strong, so too was residential construction. But when house prices fell, consents tended to fall away.

Eaqub said there were still record numbers of consents being issued, and councils were reporting a backlog of consents still to come.

But he said if the potential for profits was limited, developers would be less likely to build. New Zealand developers tended to be smaller with limited capital, he said.

Data had shown an increase in the number of residential construction businesses failing.

Economist Shamubeel Eaqub says blaming inflation solely on the Reserve Bank is 'lazy economics'.

Alex Lim/Stuff

Economist Shamubeel Eaqub says blaming inflation solely on the Reserve Bank is ‘lazy economics’.

Exports

New Zealand’s exports are reliant on the health of the global economy.

Eaqub said there was a potential tipping point in China, which is still pursuing a Covid-zero approach. There is also uncertainty in Europe due to war in Russia and fuel prices.

“The fear there will be a global recession is an intended outcome of global monetary policy… if there is, then demand for our goods and services will be reduced.”

A downturn around the world could also mean a slower recovery of tourism.

Alexander said, if higher interest rates pushed up the New Zealand dollar significantly, or if global food commodity prices fell rapidly, that could provide another export-led tipping point.

Eaqub said it was “very likely” there would be a recession.

FINANCE AND EXPEDITURE COMMITTEE

Reserve Bank Governor Adrian Orr discusses the risk of a recession in May.

“The Reserve Bank is trying to slow the economy. It’s a question of whether you believe they could stop at just the right time that we have good economic growth but inflation goes down. It’s hard to see that is going to happen. We know people are going to refix their mortgages from 2.5% to 7% – it’s going to be absolutely brutal for certain parts of New Zealand.”

Miles Workman, a senior economist at ANZ, agreed recession risks were heightened.

“While a recession is not in our forecast, we are forecasting very weak growth in domestic demand over the next couple of years, with both business investment and residential investment expected to contract in 2023 on the back of higher interest rates. But at the same time, the recovery of international tourism combined with the weaker domestic demand pulse pulling in fewer imports will hopefully see net exports provide a strong offset to weaker domestic demand.

“I think it’s also important to note that if the economy does enter a technical recession, this may not automatically mean the end of the Reserve Bank’s hiking cycle. That’s because a small economic contraction from this starting point – where economic resource is extremely stretched – may not actually be enough to drive demand for goods and services adequately below the economy’s equilibrium level.”

He said an economic slowdown driven by an “extremely stretched” economy moving to something more sustainable might not be a bad thing if it meant the country was able to return to low and stable inflation.

“But where a recession would get nasty, is if it particularly were to lead to a very sharp rise in unemployment to the point where the labor market is no longer the main driver of ‘sticky’ domestic inflation, as it is now. In other words, a big negative household income shock is the ugly kind of recession, and one that could easily tip into a ‘crisis’ as job losses result in forced house sales, sharper house price corrections, weaker than otherwise economic confidence, and ultimately a much sharper economic slowdown. Typically, when the New economy experiences an event like this, it’s a global shock in the driver’s seat.”

He said, so far, the data consistently showed demand for labor was “white-hot” and businesses could not get enough.

“But it’s also important to note that the labor market tends to lag monetary policy settings by a decent clip – 12 to 18 months – so we are looking in the rearview mirror when we take the pulse of the official labor market statistics.”

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