By Roger J Kerr
New Zealand has enjoyed the benefits of very low inflation and very low interest rates (if you are a borrower and not an investor!) for many years now and for that reason the chorus from pundits and commentators has grown stronger that it is never going to change.
The supportive arguments are that the world economy is a different place since the GFC with global loose/loose monetary policy, permanently low energy prices and technological advancements continuing to drive the cost of doing business downwards, thus no pressure to increase selling prices on consumers. Adding to the argument is the total lack of wages increases in the US, Aussie and NZ over recent years.
The counter-argument is that it is only a matter of time before the traditional economic relationships re-emerge and strong economic growth causes demand to exceed supply for capital, labour and resources, which in turn forces up inflation and ultimately interest rates.
The “inflation is dead” camp mentioned above believe that these economic “cause and affect” relationships do not work anymore due to technology i.e. the previous economic models are redundant! Well, the recent statement from the US Federal Reserve that they are still on their stated track for one further 0.25% interest rate increase this year and four more next year confirms to me that they do not believe their economic models on predicting future inflation are out of date.
The Fed have always been of the view that the pull back in US inflation earlier this year was purely temporary. The interest rate markets never believed it. However, recent data suggests the Fed are on the right track. Eventually the interest rate markets will be forced to adjust their forward pricing upwards and that means higher US bond yields and NZ swap rates (beyond three years) over coming months.
I have spent the last two months travelling around the US as a tourist, and whilst purely anecdotal observations, I noticed a lot of “hiring” signs placed outside all sorts of business premises.
Whilst US wages have yet to move significantly upwards, the changing demand/supply equation will inevitably require a higher price response. The US National Parks we went to were crowded with European tourists, so that tells you the US dollar is too weak! Seemed to be a hell of a lot of road improvements going on as well!
Most local financial market and economic commentators would expect higher NZ interest rates if we get a Labour/Greens/Winston coalition Government due to fiscal deficits, higher debt and higher inflation from a lower NZ currency value and higher wages from a squeezed labour supply due to reduced immigration.
The other worrying aspect for me from the stated policies of these three political parties is to review the Reserve Bank charter to a dual mandate of both stable inflation and employment.
They will say the US Federal Reserve has this dual mandate, so why not NZ? The reality us that there are major differences between the two economies. The US economy is 80% domestic, New Zealand is export dependent. Our employment conditions move with how well the export economy is going and that comes back to export commodity prices. There's not a lot the good people at the Reserve Bank can do to change those economic and market forces.
Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com