Coronavirus Covid-19: How economy will cope if we can’t eliminate Delta

What happens to the economy if we follow NSW and fail to eliminate the Delta variant of Covid-19?

Sydney based research group Capital Economics has modelled an economic scenario for New Zealand based on the assumption that restrictions will now remain in place until near the end of this year.

But as grim as that prospect is, it does not mean economic collapse.

The most obvious shift in Capital Economics’ forecasts is that they see the Reserve Bank delaying rate hikes until May in this scenario.

“The current outbreak is New Zealand’s first encounter with the Delta variant, which across the world has proven to be much more difficult to control than previous variants, writes Australia & New Zealand economist Ben Udy, in his relatively pessimistic assessment.

“Admittedly, the lockdown is extremely strict as non-essential construction and manufacturing are banned and restaurants aren’t even allowed to sell takeaway food,” he says.

“But given the extensive spread of the virus before the lockdown, we suspect cases will continue to rise in the weeks ahead”.

With New Zealand’s policy to continue with its Zero-Covid strategy even once most of the population is vaccinated, the failure of Level 4 to completely eliminate Covid would mean that restrictions will have to remain in place for the foreseeable future, Udy says.

However he argues that the government would likely abandon that strategy and adopt a similar plan as Australia, keeping restrictions in place until 70 per cent of the adult population is vaccinated – towards the end of the year at current rates.

The New Zealand economy has shown it has the strength and resilience to cope with this scenario, Udy says.

This scenario could see a 2.5 per cent decline in activity in the third quarter followed by a stagnation in the fourth quarter of the year, he forecasts.

“That’s much smaller than the 9 per cent [q/q] decline in Q2 last year. But we suspect that consumption and investment will prove more resilient this time around as has been the case during repeated lockdowns elsewhere,” he says.

Exports were unlikely to suffer as there was no universal tightening of restrictions overseas.

However, activity would clearly be much weaker than the RBNZ recently forecast, “especially in the very near term”, he says.

On that basis Capital Economics now sees unemployment rising to 4.3 per cent.

Udy notes that the reintroduction of wage subsidies and the high level of job vacancies prior to the Delta outbreak will prevent a sharp deterioration.

On the assumption that the Reserve Bank won’t be keen to hike while restrictions are in place Capital Economics shifts its call for a first rate hike to May.

However it then expects the tightening cycle to resume, forecasting five rate hikes until the OCR reaches 1.50 per cent by mid-2023.

Udy acknowledges this outlook now puts Capital Economics at odds with the broader market expectation – which still sees three rates hikes by May next year.

“If we are wrong and cases are brought under control in the weeks ahead, rate hikes in November and February are still on the cards,” he says.

“But for now, that seems too optimistic to us.”

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