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David Hargreaves says the RBNZ needed to send a message to the markets that rampant inflation is its sole priority at the moment; an approach that is made possible by the - for now - buoyant state of the labour market

Bonds / opinion
David Hargreaves says the RBNZ needed to send a message to the markets that rampant inflation is its sole priority at the moment; an approach that is made possible by the - for now - buoyant state of the labour market
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So, battle is now well and truly joined as the Reserve Bank firmly squares up to our rampant inflation.

To me the Official Cash Rate decision was about two choices for the RBNZ: Either show the market it was dead serious about getting on top of inflation, or take a ‘not too hot, not too cold’ approach and attempt to take the edge off inflation without running the risk of skittling the economy.

It has decided on the former. The dead serious approach. That tells you inflation is the number 1, 2 and 3 priority at the moment.

The RBNZ probably felt it needed to push that message to the financial markets.

Economists, commentors and other market participants were very sharply divided on the size of the hike. It’s been a while since I recall opinion being so divided on what the best course of action for the RBNZ was.

And roughly speaking, the division was between those who felt there was no option but to go ‘full hawk’ with a big hike and those who felt that there was enough negative momentum already - through things like weakening house prices - to slow inflation, and that to go any harder would risk wrecking the economy.

The thing is though, that ‘going easy’ with a 25 basis point rise in the OCR would likely have - in the estimation of those in the markets - seen wholesale interest rates retreat from where they have been.

I think that realisation, as much as anything else, is what would have prompted the RBNZ to put the foot on the gas.

It actually wants aggressive wholesale interest rate pricing and it wants to see more upward pressure on the mortgage interest rates.  A ‘mere’ 25 basis point OCR hike when the market pricing was indicating more would have sent the wrong signal. A ‘double banger’ 50 basis point move will see the pressure very much on in the wholesale markets.

So therefore mortgage rates will be moving up again too.

As I say, this is an inflation first, second and third strategy, in terms of priorities. Kill the inflation and to hell with the economy - for the moment anyway.

Well, is ‘to hell with the economy’ entirely wise?

Of course not. But this is inflation. There’s no good options here. We have rapidly moved into “what flavour of dead rat would you like to swallow?” territory.

Look, we are talking about a current OCR of 1.5%. Fail to control inflation now and all that happens is that OCR has to go higher later. That could be bad. Very bad.  The RBNZ has reasons to want to avoid that.

In the mid-to-late 2000s the RBNZ was generally considered too late and too passive in pushing back against inflationary pressures.

This resulted in a string of 25bp rises that saw the OCR go all the way up to 8.25%. Yes, 8.25%!

This for a spike that took inflation up to a peak of 5.1% in the September quarter of 2008.

That’s right, JUST 5.1%.

Well, we’ve already hit an annual rate of 5.9% as of December and the odds are pretty good the next annual figure to be unveiled later this month will have a ‘7’ in front of it.

Food price rises are already running at 7.6% as we saw just prior to the RBNZ decision.

To go back to the OCR then, when it was topping out at 8.25% in 2007, floating mortgage rates were around 10.5% and the two-year fixed rates (standard) were about 9.5%.

Wow.

How quickly we forget.

To just indulge in a bit of idle arithmetic with the interest.co.nz mortgage calculator, the February mortgage figures from the RBNZ show that in that month the average sized mortgage for a first home buyer was $566,500.

The FHB at that stage might have been able to get a two-year special fixed rate at 4.25%. Over a 30-year term this would be costing $2787 a month. Not inconsiderable, but doable. Just about.

At 9.5% the same mortgage would cost $4763 a month, or $57,000 a year.

Aaaaaaarrrrrgh.

Instant ruination, unless you were already wealthy enough to probably not need the mortgage in the first place.

Okay, that’s probably a ridiculous example, but I do recall shades of disbelief meeting suggestions less than a year ago that mortgages could soon be heading over 4%. That it was a risk. A lot of people could never see inflation occurring again and therefore never see high interest rates again.

Well, we’ve now got the galloping inflation.

And the RBNZ knows full well that unless it can rein in the inflation, its only recourse is to keep jacking up interest rates.

That 40% house prices surge/bender that we went on from the start of the pandemic in early 2020 to the end of 2021 has left us mightily exposed.

The sheer size of mortgages now is a huge vulnerability.

The RBNZ is very well aware of this. And it is very well aware of not wanting to push interest rates to levels that start to cause undue stress for homeowners.

Loads of houses all being put on the market at the same time in a forced-sale situation would be disastrous, with huge ramifications for the banks and feeding misery into the whole economy.

The big shining light in all this for the RBNZ is the current super-buoyant state of the labour market, with unemployment at just 3.2%. If people stay in work and receiving regular income, they can meet interest payments.

But of course any rises in interest rates - and they are really just getting started now - are going to be felt by mortgage holders as their fixed rates come up for renewal. Omicron is already suppressing spending. Higher mortgage rates will do this and more so. Businesses are already feeling the pinch. There will likely be more trouble ahead for them.  

At the moment the RBNZ can take comfort in our low unemployment levels and therefore just go hammer and tongs at inflation, reasoning that the economy for now can ‘take’ the higher interest rates.

But if we start to see rising unemployment levels and pressure on the housing market as a result, then this all becomes very different. And even more difficult.

The twin perils of a tanking economy and rampant inflation are something we don’t want or need. That’s what the RBNZ is trying to avoid.  It has a job on its hands. A hell of a job.

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25 Comments

Pucker up people. The fun is just getting started!

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I would order popcorn and ice cream, but they are priced way above my budget. Inflation, you see.

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7% Interest rates will seem cheap soon.

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Spam

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Kjeldorian / HouseMouse, same person.  If you keep acting like a parasite then we will have to call you HouseLouse.

https://en.wikipedia.org/wiki/Louse

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maybe 7% is an underprediction. Maybe more than that! 

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It has a job on its hands. A hell of a job.

If it’s a problem they helped create does that make them self employed?

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15

Lol, yes you can pat your self on the back for saving the economy with QE,

Then be hailed as a hero for saving the country from the perilous evils of inflation that you created later by raising interest rates?? 

Its a win/win, unless your on the other end of it which is 99% of us...

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Did you know that a disproportionate number of arsonists are firefighters?

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Good analysis, David. Agreed, especially on the right message needs to be sent. I think lots of people still don't understand the seriousness of current situation. And if RBNZ send the wrong message, the consequences would be far greater. 

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Bit late looking in the rear view mirror,  crash is under way . Can't help but wonder about double digit inflation and interest rates,  it will be interesting to see what the latest inflation rate turns in at . Between inflation and interest rates this could get very uncomfortable,  I remember well the eighties and seems to be many similarities here now with oil prices etc . Don't recall much sympathy from reserve bank when our mortgage was running at 22% and overdrafts as high as 45% .

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At the moment the RBNZ can take comfort in our low unemployment levels and therefore just go hammer and tongs at inflation, reasoning that the economy for now can ‘take’ the higher interest rates.

US gasoline surges 18% in a single month - March CPI 2022.

I hardly expect NZ to fair any better and 50bps OCR hikes won't cut it and to borrow a statement from Alhambra:

No one has to imagine the public outcry and anger. More than anything, this right here is the Fed’s rate hike scheme. And it’s ridiculous theater because raising the fed funds target range won’t get a single drop more oil out of the ground and into the hands of thirsty refiners. Link

But look out for demand destruction to achieve the desired impact.

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NZ to "fare" any better

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Thanks.

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Excellent article.

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Absolutely, those who predicted a 0.25 rise should learn from this article.

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We could just call this the Big Squeeze?

A central bank induced pain felt everywhere in the western world - all at once... the fruits of massive amounts of QE

I think there is going to be a lot of pain ahead for those with high levels of fixed debt that will roll over into higher rates in the next 1-2 years

Going to squeeze discretionary spending

Do you think labour will encourage 'an inflation elimination strategy' as it did with COVID? if so we have a world of pain ahead - so much for the 2% rule...

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Indeed. As spending tanks, everywhere, don't loose your job that was being propped up by that spending. Your bank or landlord will not understand.

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Makes the next REINZ monthly HPI data a must read - tomorrow if I'm not mistaken?

 

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Happy with the 0.5%. And hoping for another in May. Demand is slowing already & it will be a long winter in 2022 wherever you are. Hopefully there might be some light at the end of the year but for now, it's baton down the hatches.

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Excellent article David, I hope all those who thought a 25bps rise was justified, read your article.

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"Inflation is the number 1, 2 and 3 priority at the moment."

Well we very much agree David, I remember predicting that "the 3 main issues for 2022 were going to be Inflation, Inflation and Inflation."

Sadly I couldn't find that post, I only found this one:

by Yvil | 31st Dec 21, 2:50pm

For me, the overriding issue for 2022 both for NZ and worldwide is Inflation.  Of course there are many other important aspects such as GDP, employment, housing, asset values and many more but IMO they will all mostly depend on inflation and the central banks' response to said inflation.

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I remember you posting that specific sentence. Credit where it's due :-)

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Thanks RS

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Confuscius says: People who get excited about 50bp OCR increases need to get out more!

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