Worst yet to come for economic disruption, ASB warns

The worst is yet to come for New Zealand households feeling the impact of the Middle East conflict, ASB warns.

The conflict is entering its 12th week and the Strait of Hormuz closure is impacting fuel prices around the world.

"While the immediate effect has been higher fuel prices, that's only one piece of the puzzle," ASB senior economist Kim Mundy said.

"The broader story is how the entire cost shock - which includes fertiliser and petrochemicals - spreads through supply chains, lifting the cost of manufactured goods, packaging, freight and farm inputs, and the flow-on effects of that to consumer spending."

She said freight operators were experiencing the biggest initial cost increases.

ASB expects the initial inflationary pressure to be felt most acutely in food, freight, plastic products, and other goods with high transport or packaging costs.

At the same time, discretionary sectors such as retail, hospitality, arts and recreation might face softer demand, as higher fuel costs reduce household spending power.

"The effects of the Strait's closure reach further into the economy than may have first been apparent, with few sectors likely to escape entirely," Mundy said. "Agriculture, manufacturing, construction and transport appear most exposed, but even less fuel-intensive businesses could be hit, as households shift spending towards essentials.

"That creates another headwind for economic growth."

While the government has indicated the risk of a fuel shortage and rationing remains low, ASB urges businesses to review where they are exposed and prepare for ongoing volatility.

"Roughly a quarter of our economy has a high or very high exposure to at least two of the key disruptions we analysed in our research," Mundy said. "For businesses, the message is to look beyond direct fuel use, and assess their exposure across suppliers, freight, packaging inputs and customer demand, while the conflict in the Middle East persists."

She said most households had not felt the full impact yet.

"A lot of the impacts will be sort of business to business, if they are pushing up their prices, and then over time, they can flow through to that consumer space."

She said it was hard to know precisely when that would happen.

"If you're looking at some of the potential price increases we might see off the back of the fertiliser impacts... it is twofold. It's what it's doing to farm import costs and then how that might flow through to higher food prices.

"Another thing to think about is whether or not farmers will use less, and then you'll get lower yields. There's a lower production side of things, which can also lead to higher prices, but that's not really something we'd expect to see strongly, until maybe around the end of the year."

She said the effect was likely to linger.

"Once inflation goes up, it doesn't often go back down again by the same degree. I think, in some areas, we could easily be feeling these impacts for a long time yet."

She said the conflict had "significantly" set New Zealand's economic recovery back.

"We've had multiple quarters now showing that consumption was broadening. The economy was gaining momentum, but we are expecting Q2 will show a contraction... that flows through to more uncertainty for households.

"It's the psychological element of people feeling like we were really finally getting there and we were getting back on our feet, and that's just been completely kind of cut off at the knees.

"The housing markets weakened, April electronic card transactions data was soft, business confidence has fallen, consumer confidence has fallen - it has really pushed our recovery back."

She said ASB economists wanted to warn businesses that the disruption from the closure of the Strait of Hormuz could show up in a number of ways.

"Maybe in ways that aren't so straightforward and so obvious. Just to get people thinking about some of the ways we can be impacted by this… and hope that it opens again soon."

She said businesses could make changes to avoid higher costs, such as moving to fertiliser based on seaweed rather than oil, where possible.

"Often, there are other headwinds that come with substitution, and it's not always quick and it can take time. There are things I think businesses can be looking into, if they want to try and shelter themselves from some of these costs and uncertainty."

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