From the beach 2011

From the beach 2011

To spend or to save?   Households have veered towards the latter over the last three years’ good news for the perceived imbalances in the economy but bad news for businesses hunting for the consumer dollar.   Firms will be hoping for some respite from the consumer frugality in 2011, but the spending pick-up looks like it will need to occur without any assistance from the housing market at least in the first instance.

Savings mania

Over the last couple of years, one of the biggest areas of disagreement among economists has been how sustained the consumer response the global financial crisis would be.   The themes of rebalancing, debt reduction, and increased savings rates have been repeated ad nauseum since the financial crisis hit, credit became more difficult to obtain, and household balance sheets took a hit because of falling house prices.

We have argued in our forecasts that the weaker spending by consumers since 2008 is more cyclical than structural.   We are holding fast to that view, but recognise that even if the weakness in spending is only cyclical, the downswing has been stronger than businesses would have liked and longer than they might have expected.

The good news is that new data released in December substantially weakens the case for further increases in household savings.   Our graph compares the old estimates of the household savings rate with the latest figures released by Statistics NZ, and shows a much larger correction in the savings rate since 2006 than had previously been measured.   The household savings rate is now at its highest since 2000 and is comparable to the rate recorded at the end of 1994.   Even in late 2006 and 2007, early signs of slowdown in the housing and labour markets were already starting to affect consumer behaviour well before the 2007/08 drought, subsequent recession, and global financial crisis.

Regaining confidence to spend

Even if the case for further increases in household savings, based on historical norms, is weak, the New Zealand economy is still in need of a circuit-breaker to make households feel more comfortable about spending again.   What prospects does 2011 hold in this regard?

 

  • The effects of higher commodity prices throughout 2009 and 2010 are yet to show up in spending in provincial areas.  Farmers have been grappling with high debt levels, variable weather conditions, some high input costs, and falling land values.   Will 2011 be the year where well-established farmers with solid balance sheets gain the confidence to kick-start a recovery in provincial spending?

 

 

  • Further consistent improvement in the labour market will be a key building block in the return of more "normal" spending patterns.  Employment growth has improved from its 20-year low at the end of 2009 and, at1.8%pa, is now only just below its long-term average.
  • News from the international economy will continue to be mixed throughout 2011.   US households are still saddled with stagnant housing and labour markets.   Questions remain about the robustness of Chinese economic growth in the face of soft global demand and official moves to rein in excessive growth in domestic spending.   Europe’s persistent debt problems may also affect New Zealand, particularly while ratings agencies continue to suggest we may be in line for a ratings downgrade.   But Consensus forecasts show that the world economy is expected to expand by 3.2% this year, only marginally slower than the 3.5% growth estimated for 2010.
  • One-off events, including the rebuild following the Canterbury earthquake and the Rugby World Cup, will help to boost spending activity more than underlying economic fundamentals would otherwise suggest.

 

Can we ignore the housing market?

Perhaps the biggest impediment to a recovery in spending is the housing market.   At this stage, we see little scope for a turnaround over the next 12 months particularly in terms of house prices.

So can household spending grow at the same time as the housing market is struggling?   Our second graph maps growth in private consumption against real house prices since the 1960s.

There is a good correlation between the two series, particularly over the last two decades, although it is impossible to determine causation one way or the other.   There is an obvious argument that rising house prices may fuel more borrowing and spending.   But it may also be the case that the same factors driving faster growth in spending (eg a strong labour market, high commodity prices) feed through into a more buoyant property market as well.

Regardless of causation, the 1960s is a good example of a period when household spending didn’t seem to be too negatively affected by the weak property market.   Although a strongly performing housing market is likely to enhance growth in household spending, other economic factors can be sufficient to underpin spending activity.   And more recently, if the experience in 1999 is anything to go by, a healthy economic performance can also go some way towards arresting the slide in the housing market.

Electioneering, but not as know it

It’s election year again and, on the face of it, it’s hard to see Labour getting close to National at the polling booth.   National’s current lead in the opinion polls is even bigger than the lead that Labour commanded heading into the landslide victory at the 2002 election.

This election campaign will be like no other over the last15 years.   There will be no promises of tax cuts or spending increases the fiscal position simply makes such promises untenable.   In fact, there are likely to be few promises about anything of much consequence for the economy or the business sector.   The government is yet to receive or consider final reports from the Welfare and Savings Working Groups, but the exclusion of Working for Families or National Superannuation from any policy debates implies that radical change is off the agenda.   Dismissal of anything suggested by the2025 Taskforce also indicates that National is firmly committed to holding its ground in the middle of the political spectrum.

At times over the last year, Labour has made some less orthodox economic policy proposals, such as changing the goals of monetary policy or introducing GST exemptions.   However, Labour’s ideas have failed to gain much traction with the public, and voters seem willing to give National more time to oversee the economy’s recovery from the global financial crisis.

The catch for National is that their support party base seems less assured than Labour’s was nine years ago.   It’s conceivable that some combination of the Greens, Maori Party, and NZ First could garner enough votes to get Labour over the line.   Although centrist parties have historically shown a willingness to support the largest major party in parliament, there is no reason why this outcome must always occur.

In a policy vacuum, the election will largely be fought around personalities an area where John Key has an advantage over Phil Goff.  Expect the presidential-style campaigning that has developed over the last decade to become even more entrenched at this year’s election.

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