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.