This opinion piece was first published in The Post on 1 May 2023.

This weeks’ release of unemployment and wage inflation data will probably add weight to the view that the New Zealand economy is slowing. But despite a likely uptick in the unemployment rate, it seems too early to expect a significant shift in the key numbers on Wednesday. The labour market is typically one of the last indicators to reflect a change in the economy’s momentum, either upwards or downwards.

For now, the critical labour shortages of the last couple of years are still dominating the thinking of many business owners, meaning they are hesitant to fully consider the implications that weaker demand might have for their staffing requirements. Add in the fact that workers are desperate to be compensated for rapidly rising living costs, and it’s easy to see how this week’s data could still be uncomfortably strong.

We’re expecting a slight lift in the unemployment rate from 3.4% to 3.5%, which would be the highest rate since mid-2021, continuing a slight softening trend of the last 12 months. But an unemployment rate of 3.5% would still be one of the 10 lowest results on record since 1986. Ongoing strength in the labour market is showing in monthly filled job numbers that continue to edge higher, fuelled by growth across tourism-related and other service industries. Even with job growth in hospitality and transport running at 8.5% and 6.2%pa respectively, the tourism sector has struggled to keep up with the resurgence in demand that has occurred since the borders reopened in mid-2022.

The only labour market relief we have seen to date has been a surge in foreign worker arrivals, thanks to the government’s immigration Green List and the restoration of processing capacity at Immigration NZ. The trend in work visa approval numbers has now surpassed its 2019 peak, and migrant arrival data backs up this increased supply of workers. Even then, the effects have not been evenly felt across the workforce, with vast differences between construction, which is heavily represented on the Green List, and hospitality, which has typically relied on people coming to New Zealand on working holidays.

The unemployment rate averaged 4.2% in the two years prior to the pandemic, so further rises would be needed to get back to what we previously considered “normal”. We do not expect to see any significant moderation in labour cost growth until there is more spare capacity in the labour market. Given the cost-of-living pressures being faced by workers, including the extra pressure on mortgage holders as they roll off lower fixed rates, demands for higher wages are likely to remain widespread throughout 2023. New Zealand’s relatively high minimum wage, relative to the median wage, is also maintaining significant pressure on pay rates at the lower end of the scale. Employers are effectively forced to lift wages for other staff to ensure an appropriate relativity is maintained between new workers and people with some experience.

Against this backdrop, the Reserve Bank’s own forecasts don’t see labour cost growth peaking until the end of 2023. This outlook hints at one of the biggest remaining challenges in getting inflation back under control. The case for paying staff more is a compelling one, in terms of both labour supply issues and workers’ living costs. In an environment of high inflation expectations and regular cost increases, passing on these rising labour costs in the form of higher prices is a simple result. But it also risks keeping consumer price inflation at a higher level for longer. Recent data shows that services inflation is intensifying, even as goods inflation, with its smaller labour component, is becoming less critical.

Taken together, this week’s labour market data presents a high likelihood that all three major indicators (GDP, inflation, and the unemployment rate) are pointing towards an economic slowdown. New Zealand’s most recent GDP and inflation results have been weaker than expected, suggesting the Reserve Bank is finally getting some traction in quelling demand and starting to reduce some of the imbalances in the economy. But there’s still a lot of pressure in the system.

So unless this week’s labour market data is incredibly weak, the Reserve Bank is still set to raise the official cash rate by another 25 basis points later this month, to 5.50%. Otherwise, the Bank risks diluting the hawkish tone of its previous statement. Part of the Bank’s rationale for its bigger rate rise in April was the fact that retail interest rates were already starting to ease, despite the Bank not being convinced it had yet done enough to get inflation under control. It will want to avoid the same scenario unfolding again.

The question of a further interest rate rise in July will be influenced by GDP data and survey measures of cost and pricing pressures published between now and then. But irrespective of whether the official cash rate peaks at 5.50% or 5.75%, households should be prepared for a much slower path downwards in interest rates than the rate of increase over the last 18 months. Interest rate cuts before the end of this year should be off the agenda, and when the Reserve Bank does cut, it will opt for a more gradual approach. The Bank must avoid amplifying the economic cycle with its monetary policy decision, something that it has been guilty of over the last three years.