The next few weeks could be quite pivotal for inflation, the economy and the housing market.
Before Monday of this week there was a kind of vague narrative forming in some quarters that saw inflation having peaked and consequentially perhaps mortgage rates having if not peaked, then at least getting close to it.
But those darned inflation figures out on Monday have upset things again.
We are faced with the prospect that mortgage rates may resume their upward path soon. But it depends on how a few factors pan out within the next month.
The truly disconcerting pattern we’ve seen in the past 12 months now is that inflation figures are consistently coming in higher than expectations – when those expectations have been high enough as it is.
It’s not just been that though. As is often pointed out, there’s not too much we can do here if international oil prices, particularly, go on a tear. Inevitably an inflation shock will result.
However, the most unpleasantly surprising development amid this global inflation surge has been the extent to which inflation has taken off within New Zealand. We are importing loads of inflation – but we are making lots too.
It’s undoubtedly coming as something of an unpleasant surprise to our Reserve Bank as well. The RBNZ is guardian of a 1% to 3% inflation target that’s looking extremely fanciful – at a time when annual inflation itself is perched on 7.3%.
What the RBNZ will be looking closely at though is the measure of domestically-generated inflation. It had expected (as in its May Monetary Policy Statement) this to be running at an annual 5.7% as of June – but the actual figure came in at 6.3%. In the context of something like this, that’s a big miss.
As economists have pointed out, the good news for the RBNZ is that it can influence domestic inflation through pulling its levers – particularly the Official Cash Rate, whereas it’s largely powerless over, for example high global oil prices. The bad news though is that it’s behind the eight ball with domestic inflation at the moment.
What that means then is potentially more interest rate rises.
Many economists were disinclined to believe that the RBNZ would need to take the OCR to nearly 4% by the middle of next year as the central bank forecast in May. Many thought (and still do) that the OCR won’t go above 3.5%.
There was probably some belief that there was an element of ‘jawboning’ in the RBNZ’s forecasts. Some might have believed that the RBNZ was deliberately forecasting a high OCR figure in in order to convince people it was going to go all out to beat inflation. And by doing that it would help to kill the dreaded inflation expectations, the expectations that fuel future price rises. Once inflation expectations were more back in control the central bank could then back off a little in terms of actual OCR increases.
As I’ve said before though, I always believed the 4% OCR figure was NOT a bluff. I believed it was the RBNZ saying that if it had to force interest rates up that high then it would do. But it would happily settle for a lower figure if it saw inflation and inflation expectations were starting to come down.
Now what though?
Economists and the RBNZ had been believing that the June quarter inflation figures would represent the ‘peak’ of the inflation surge.
For the most part they are still saying that – but it seems to me the belief is rather more qualified now than it was before the actual figures came out.
Clearly the sheer strength of the underlying inflationary pressures has somewhat shaken the idea that the inflation beast can be put back in its cage quickly.
All eyes are now on the labour market figures – that’s both employment and wage data - to be released on August 3.
The March quarter figures showed unemployment at a barely existent 3.2%, while average private sector hourly (ordinary time) wages rose 5.3%.
Any sign that the labour market is getting even tighter, and particularly if wages start to spike more, and this will give the RBNZ a real shove ahead of its next OCR review on August 17.
The other significant event before that next OCR review will be the August 8 release of the RBNZ’s own quarterly Survey of Expectations, in which a small group of experts (business leaders and professional forecasters) are canvassed for their views of expected future inflation.
The RBNZ will want to see a drop in these expectations. It likes to see expectations of future levels of inflation ‘anchored’ around 2%, this being the explicitly targeted midpoint of the 1% to 3% target range. Well, the expectations are unanchored at the moment.
As of the last survey released in May the average expectation for the rate of inflation in two years’ time was 3.29% - so above the top of the RBNZ targeted range. In two years’ time.
I would imagine that until they saw the 7.3% actual inflation figure the folk at the RBNZ would have been hoping that the next survey would show a fall in expectations. After the shock of the inflation figure, and bearing in mind that field work for the survey’s going to be done very shortly after the release of that figure, it’s very pertinent to ask whether those inflation expectations WILL fall.
I mean, they might. Since the last survey came out the RBNZ has been demonstrating a real urgency to get on top of things and that might convince people that the inflation beast can be put back in the cage – but people might want to see signs that’s actually happening too. And, well, those signs aren’t there at the moment.
Worst case scenario could be labour market figures out on August 3 that show the jobs market tighter than a tight thing, coupled with sharp wage rises, and then a Survey of Expectations on August 8 that shows little or no lessening of future inflation expectations.
That could be the cue for the RBNZ to reach for the blunderbuss and go with a 75-basis-point increase to the OCR, taking it to 3.25%. The other thing very much worth mentioning is the rates decision by the US Fed late next week. The debate there is whether rates will be increased by 75 points, or even 100. A 100 pointer would certainly give a green light for our central bank to clap on the gas as well. Well, let’s face it, a ‘mere’ 75 pointer won’t exactly be a discouragement either.
In the meantime the speculation is that the Reserve Bank of Australia may well do a 75 pointer in its next review on August 2.
Ultimately, the real important thing is what all these combinations of events might do to wholesale interest rates.
It was the super-sharp rises in wholesale interest rates – ahead of actual OCR increases – that led to the big rise in mortgage rates, with, for example, the average new one-year fixed rate rising from about 2.3% at the end of June 2021 to 5.2% at the end of June 2022.
The wholesale rates had been falling recently, but spiked again after the inflation figures on Monday. The ‘market’ is currently priced with an expectation of the OCR peaking at about 4.1% early next year.
If the various forthcoming events highlighted above contain some unpleasant surprises (and chances are they may well) then its not hard to see those wholesale rates climbing again.
And if that happens further mortgage rate rises will follow.
I’ve always thought – just sheer gut feeling really – that we could really be in trouble if we see fixed mortgage rates hit 7%. We are not far from that already with some of the longer term rates (IE five years).
If some people really start to struggle with mortgage payments, ‘at best’ this will curtail spending in the economy. At worst we could yet see distressed housing sales. And that would put further downward pressure on a housing market that after hitting the highest of highs has now seen prices decline about 7% since late last year.
So, it’s a pivotal few weeks for the economy. Fingers crossed.
88 Comments
Interest rates have not peaked. Inflation has not peaked. Only the Vested Interest Brigade would spin this to the sheep. Just follow the money.
The Market Is On Fire.
Yes I would say the banks will have to reverse the cuts they recently made to the 2 yr mortgages. I think 6% mortgages will be required to cool this inflation. I see the call and bonus savings accounts have gone up today. ANZ serious saver now 1.8%. Rabo Premiun Saver still the best 2.3%. Was looking at TD break rates between the big banks recently, ANZ the best, 1% penalty. Some with effective break penalties of 3%. Have been quite impressed with ANZ on a few issues lately.
I don't really have any vested interests but I think it probably has peaked. A big chunk of that inflation was a massive increase in oil costs and in building costs, I don't see why either of those should rise by so much again. But who knows, picking the peak of anything is very difficult, if you can do that you should be very rich.
We have had massive asset price inflation and low consumer price inflation. There is no way to prevent consumer price inflation now, without crashing asset prices. Crashing asset prices would mean economic collapse, Weimar style.
The long-term effects of money printing should have been considered beforehand, much like the long-term effects of mass experimental vaccinations. Once the money has been injected into the bloodstream of the economy, it cannot be taken out again without the economy going into cardiac arrest.
Ultra-low interest rates set by the RBNZ coupled with a money-throwing-around government have gotten us into the mess we are in: a highly leveraged and housing-dependent economy.
Who in his right mind thinks that the RBNZ will get us out of the mess they helped create? Interest rate rises will not destroy inflation, they will destroy our entire economy. If they continue, we will have mass insolvencies including bankrupt banks.
The only way out now would be to accept inflation, which is inevitable anyway. Eventually, when the debt mountain has been devalued, interest rates can be hiked aggressively - but not now!
So, first let me say that in case of NZD down and high inflation I will be personally in a better situation.
That is only to say that is not in my interest that I am going to say what I am going to say.
Letting inflation go is basically a form of bail out. Everybody pays.
Rising interest rates instead is punishing firstly people that accessed to too much debt.
I don't think is just/right.
I think we had enough moral hazard already
Yes, inflation is pretty bad for everyone. But economic collapse is worse. Economic collapse is what we are facing with our highly leveraged and property-depending economy if interest rates keep rising.
Inflation, driven by years of money printing (figuratively speaking) and now also via supply constraints and a loss of confidence in fiat currency, cannot be avoided. Economic collapse could still be avoided at this point (by lowering interest rates), but I am not sure what the great reset plan entails.
The problem wasn't caused by the RBNZ.
The problem isn't interest rates going up.
The problem is the debt....and the people who took on too much debt and cant service it as the economic environment pivots will cop the fallout the worst.
As it has always been.And that's the way the system works.
I think that it may well come back to the disconnect been house prices and wages.
We have to raise wages to retain people in the country. Otherwise they will just leave the country in increasing numbers. This of course generates domestic inflation so the RB is forced to increase the OCR. The rising interest rates will suppress house prices.
So the rational direction is lower house prices and raise wages until they achieve a more reasonable balance.
If we do not achieve this then, as the National party would have it, we will end up as a country full of 2nd and 3rd world low wage immigrants as serfs, living in unaffordable homes owned by the landlord class. I.e. a banana republic.
Yes. Stupid, aren't we. It really illustrates how the whole of our economy and ultimately the employers of the productive sectors are geared to financing out of control house prices. All costs have to ultimately financed from this point. The only way out is to raise interest rates to crash house prices.
Nice commentary, David. It seems to me the Reserve Bank could do more to 'condition' inflation expectations and build some needed credibility around bringing inflation back down. One way to do this would be set an interim target for inflation - in agreement with the Minister - so that people have something to focus on. For example, CPI inflation down to 4% by end of 2023 as a transitional step back to 1-3%. At the moment the path down just seems all very vague and non-commital ...
I agree it's a good article. Two thoughts:
1) If RBNZ do reach for 75bps next month, which I think is possible, retail floating rates will be 7%.
2) I tend to agree with David's interpretation of yesterday's inflation reading, but I was surprised by how muted the swap response was. Perhaps others are seeing something different.
Reserve Banks rarely spell it out for the masses, that's the job of the media....
Let me spell it out for you, RBNZ seems to yet have no traction on inflation, though it is a lagging indicator. A Lot is now baked in, who wants a 3-4 % pay rise here?
So for those who cannot read between the lines
The Landing looks a lot HARDER now then it did last week.
Their job is now to make sure that the hard landing does not turn into a crash landing. IMHO they only go 50 next meeting. I think the housing market is going to do some of the lifting for them....
I can see a downside to that approach, which is that you may trigger wage negotiations in the here and now with that figure already in mind; if I know inflation is still going to be circa 4% by the end of 2023 then I'm going to want to get ahead of it sooner rather than later.
The other there is it firmly and consciously acknowledges the failure of the PTA and the total lack of scrutiny or accountability at a political level for it. I'm gathering being that up-front about it is something that Robertson et al want to avoid if possible.
This is called Managing inflation expectations in RBNZ speak....
As they have failed they now need to make people scared of losing their job and having to sell their house... this takes away bargaining power.
If they go 100 it smells of panic (like RBC) , 75 will manage expectations but risks collateral damage in housing market 50 imho is perhaps more sensible 25 is off the table.
They will look to the data/housing market condition etc that comes out before 18th August
- 18 August - MPS Media conference & live-stream
- 6 October - MPR
They don't have any mandate re the housing market but a blind man can see a CRASH here is going to cause economic damage.
Tāne Mahuta may be developing die back here.....
Agree completely. Past examples of structural inflation tell us:
1) Structural inflation lasts for years, not months or quarters
2) It is perfectly normal for inflation to rise, peak, drop, and then rise and peak above the previous peak months, or even years, later
3) Taming inflation requires demand destruction but also supply creation
4) It will take around a decade for inflation to return to normal levels
5) During that decade, we will see prices for everything rise and then normalise at higher prices
RBNZ has existed since 1936 and inflation targeting has been primary tool since 1989....last major inflation spike ran from the 1970s and could be considered tamed by 1990.
https://www.macrotrends.net/countries/NZL/new-zealand/inflation-rate-cpi
DDS,
4) It will take around a decade for inflation to return to normal levels.
What do you consider normal? !-3% as for the RB, or some other figure? Your call of around a decade might depend on your answer, but I tend to think that it will be significantly lower-say 3%- much much sooner than that.
The RBNZ WILL do a 75bps increase IF the market is pricing it at the time. They will take a least resistance path and adopt the soft approach. Currently the market is pricing in an 87% chance of a 75bps move so it is not far off that. As far as your comment "IF some people really start to struggle" I think we are past the IF stage as fixed interest rates roll off and current levels are applied. Watch the pressure come onto the 2 year duration of the Interest Rate Swap curve as people look for some certainty albeit at unattractive levels
Actually most term break-evens are back to, or near the average. The US 15y b/e is at 2.58% and has a long term average of 2.48%. Rates are going to come down as quickly as they went up as demand collapses. Even though the OCR will rise again, we are actually on the way out of this pulse. In the UK for example, the 30y RPI swap is 3.24% and was at 3.50% 2 years ago.
"Before Monday of this week there was a kind of vague narrative forming in some quarters that saw inflation having peaked and consequentially perhaps mortgage rates having if not peaked, then at least getting close to it."
Only by those vested - the mortgage brokers (Bolton), property economist (CoreLogic, T.A), bank economists etc
The reality is no one knows when it will peak and at what level
Why don't we start getting the opinion of some academic economists that aren't vested and who might call it straight
Though I'm sure the vested parties will then just label them Dr Doom like they did Nourbini when he predicted the GFC
I think the war is the big factor that’s casting uncertainty. I know there are a lot of people who post here who have been arguing for a while that this inflation isn’t transitory. I was certainly in the transitory camp, and am of the view that inflation would have started subsiding much more by now if it wasn’t for the war. But we have the war, it looks like going on for quite some time, and it’s going to continue to have a significant inflationary impact.
so, discounting a black swan event, all things being equal the OCR will rise to between 3.5-4%, and the NZ economy will be in a deep deep hole by early 2023.
accordingly I have updated my house price forecast of falls of 15-20% from peak, to 25-30%.
But surely the war is a one off event inflation wise. That supply has been removed from the market, the prices have now adjusted (and if anything started coming down again), why would prices go up again? Maybe a big change in the war would do that, but that could go either way (for example a ceasefire).
I commented a few days ago that fuel prices had dropped and maybe the worst was behind us. But someone made a great reply that the northern hemisphere summer might be a big part of that, and let’s see in a few months when it’s winter up there and Russia isn’t supplying Europe.
ceasefire? I am not particularly optimistic, I think this could easily go on for at least 1-2 more years, and who knows the end point.
A builder rang the Mike Hoskings show this am, said in 20 years experience house construction costs tend to always run multiple times inflation, he stated house construction costs are up 18% over the last year compared with a CPI of 7%.
This will mean residential construction grinds to a halt with huge damage to tradies. If this starts no amount of cutting ocr can stop it, not that the rbnz may have that option.
If house prices fall 30% in a year, that smalls of wealth deflation while we have cost of living inflation. The peasants may revolt.
No brainer. I have been calling that since mid 2021.
huge rise in construction costs + large rise in finance costs + oversupply + plunging house prices = carnage in the residential construction sector (and its large range of related businesses)
probably still won’t see it getting really ugly till late 2022/ early 2023, given there are still many projects under construction (some will fall over, but most won’t)
the construction rises are reversible though
Lumber / log prices are heading down and the Gib crisis will be over by xmas.
Once the heat comes out of the building boom and competition returns, tradies stop over inflating their quote prices.
Building boom bust cycles are harsh, but thats what we have..
For anyone that thought the double digit rises year on year were fine and just a function of the market (and happy to see so) whilst interest rates were dropping to rates not seen in over 60 years then there should be no surprise that the pull push of the OCR magnet works both ways ....
It took a long time to rachet this high... it will take a long time to bottom out and turn around ....
best of luck out there... I suspect we'll come back to earth and end up cheaper than your major cities in Aus which seems correct looking at wage to price ratios
The CPI figures for domestically-generated inflation are really misleading. The weighting used to calculate tradeable and non-tradeable inflation has not been reviewed since 2020 - so they reflect the balance of input costs pre-Covid. For example, increases in the prices of ready to eat food (takeaways / deliveries) are a key driver of the CPI increase and are considered to be 100% domestically-generated by Stats NZ. But, anyone with half a brain can work out that increases in the price of takeaway food are related to increased costs of food and fuel, which are driven by offshore factors, coupled with changes to consumption patterns (more delivery less collection). The cost of getting a house built is similar - 100% domestically driven according to Stats NZ. Really? So, no reliance on international-sourced steel, timber, building materials, fuel etc?
The situation we find ourselves in is largely a consequence of excessive QE and excessive lowering of interest rates, both here in NZ and more broadly in Western countries. These policies were enacted far too fiercely in 2020 and thereafter for far too long.
I wrote about those flaws in a series of articles at interest.co.nz, starting way back in June 2020. Here is the first one. For the whole series it is easiest to go here where they are grouped together.
Unfortunately there is no way to now get the genie back in the bottle without a significant recession. NZ living standards will have to drop, but society is not going to readily accept that. Each sector of society expects other sectors to wear the pain.
KeithW
The possible blast radius of this bomb has been "improved" day by day whenever anybody accessed more and more debt.
The level of negligence is unbelievable.
"Each sector of society expects other sectors to wear the pain" <= true
I don't see a problem where debt was used to improve productivity, to create something new, to build wisely. It will be difficult, but those companies will survive.
But we all know that there is not where most debt has been directed...
You were spot on back in 2020 and you are spot on now Keith. Because the RBNZ acted way too late in reigning in its stimulus it has backed itself into a corner, and the only way out is to eventually push the economy into a recession. A lot of the pain could have been avoided, but that time has long since passed.
All this Russia chat - how much do you think its actually effecting the world economy or just a good reason to increase costs? Only 10-12% of the worlds oil produced in Russia, some interesting charts in link.
https://www.aljazeera.com/news/2022/3/10/infographic-how-much-of-your-c…
Why are people struggling to understand this. It's really simple. You need mortgage rates higher than inflation rates to bring down inflation. RBNZ is effective 200basis points behind where it should be. And because of that, we are going to see inflation hit 9% by Xmas which means the OCR will hit 5.75% before they start to see inflation falling. House prices will be the casualty with 50% fall, and unemployment will be the casualty with 100,000 job losses in the next 2yrs. This inflation will take far longer to get under control. If I was RBNZ I would come out tomorrow and initiate a 100bp rise and another at the August meeting. But the inflation genie will live longer because the RBNZ are weak, and our Govt is the most incompetent Labour govt in history. History will draw parallel between the 3rd and the 6th Labour Govts. Both economic debacles. Both economic mismanagement. Both likely followed by a 9yr National Govt
"It's really simple. You need mortgage rates higher than inflation rates to bring down inflation."
And, ideally, you need that to happen in advance. Chasing inflation with % rate rises is acknowledgement of monetary failure. The RBNZ needs to get out in front of the problem, now. And that is going to make today's OCR look flaccid.
sooo...
if you can get 100k for 10 years at 2% but inflation is 3% you can expect that if you invest in anything that runs like the inflation you make 3% but you must give back 2%, which makes you 1% richer every year.
That is the theory.
In practice is much more complex than that, so the correlation is not that linear.
But yes, from another pov, if you want to fight inflation you must make the cost of money so high that getting in debt is a bad deal.
Someone needs to interview Donald Brash and ask him what he would do if he was RBNZ Governor. Now bearing mind that Don Brash is the American equivalent of Alan Greenspan, despite Dons political beliefs he is the guy that tamed NZ inflation by 1991. I am dumfounded by the idiots we have at the helm now. They have turned NZ from. Net Zero govt Debt in 2008 (thanks to Helen and Michael aka scrooge McDuck) to a country with 50% govt debt to GDP and all this in Just 14 years. You will all pay dearly for voting in that fat finance prick and that buck tooth Hobbit for a PM. Let the great white exodus begin
Im sorry but the RBNZ can not keep raising the OCR as its done in previous years because this time they created to much fake money and flooded the economy with it and blamed the big C. The only way out of this Ponzi Scheme is they have to keep printing more money.
KW is spot on. We've created this mess ourselves. Covid is a virus, but it doesn't run the country. The govt runs the country & it is doing so into the ground at the minute. The last time I saw such incompetence was when Bill Rawlings took over from big Norm in the mid 70's. Not even Piggy Muldoon at his worst was this bad.
The Taylor Rule has proven to slay high inflation - as many have said Mortgages/Lending cost need to be set above prevailing inflation, to curb it.
We should have all mortgages above 7.5% right now.
Ok they are not......
So inflation is still raging and it almost assures rates will need to go much higher in the future.
The RBNZ have lost control and pissy little 50bps jumps are no where near enough to cage this inflation tiger.
We need two quick 100bps jumps then revert to the pissy 50s. With 8-9% lending - hey presto inflation is caged in 2024.
1 yr mortgage usually about 2.5% above OCR, TDs about 1.5% below the mortgage rate. But TD rates are distorted at present witt the FLP still running and Kiwisaver funds with nowhere to put their money. Interesting that some kiwisaver funds are the banks themselves, and they were taking their own low rates recently....And in Oz TD rates are very low at present due to government guarantee.
Justa comment, thank you, you have answered a question, as my brother who works overseas, sold out of the AKL property market in late 2015 and basically put that money in an NZ bank. But is now worried, as to just how much those funds are "guaranteed" ?
Sounds to me Aussie bank deposits are covered, but NZ banks don't want to pay the "costs" of guaranteeing their citizen's money :)
So I could state, that your funds held here in NZ are at the "whim" of the markets, and if the SHTF you could lose them ?
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