Consider yourself officially ‘shocked and Orred’.
The Reserve Bank, led by Governor Adrian Orr has brought out the heavy artillery for the final Official Cash Rate review of the year with the largest increase since the OCR was introduced in 1999.
The main reason for the increase would be to ensure that tension was maintained in the markets. The markets had been expecting a large increase, so, to do something less than that would have been to risk wholesale interest rates falling - which the RBNZ absolutely does not want now.
Arguably even more rousing for the markets would have been the RBNZ's forward projection that now sees the OCR peaking at 5.5% in the second half of next year and staying at that level for a year.
From the central bank’s perspective, it is seeking to get maximum ‘bang for its buck’. It wants to ensure that interest rates are driven up, hopefully as it would see it with an accompanying rise in the value of the Kiwi dollar (because that makes imports less expensive and therefore less inflationary).
The latest OCR hike should see further increases in mortgage rates - and this is where the squeeze on the public really comes on. People seem to be handling it well so far, but appearances can be deceiving, and a fair few people on fixed rates will not have had their payments increased yet. The pain is still ahead. And we are yet to see how this will all pan out in terms of slower spending in the economy - and a subsequent fall off of inflationary pressures.
But outside of what the RBNZ is looking to achieve with such a large rate rise, the sheer size of the latest hike actually betrays unease on the part of our central bank.
By seeking to cause further reaction in the markets, the RBNZ actually reveals its doubts and discomfort with the current state of play vis-a-vis the battle against inflation.
The RBNZ is effectively telling us, without saying so, that it’s not seeing enough sign yet that it is cooling things sufficiently in our over-heated economy to start taking the steam out of inflation. And inflation is getting a fair head of steam.
The impact of the nasty shock that was the annual Consumers Price Index inflation reading of 7.2% as of September - and barely down from 7.3% in June - cannot be overstated.
The release of these figures in October was then followed by ragingly hot labour market figures, also as of the September quarter, that among other things showed a still very low 3.3% unemployment rate and annual private sector hourly earnings increases of 8.6%.
There’s already strong signs that inflation expectations are becoming ingrained. People are expecting much higher wages, businesses are expecting to need to increase prices.
The RBNZ by actually starting to raise interest rates earlier than most central banks in the world had hoped to ‘get the jump’ on inflation expectations and cut them off early. And it is fair to say that the RBNZ’s body language prior to the release of the latest inflation and labour market figures had suggested it felt it WAS getting on top of things.
But as things stand right now, it’s hard to see the labour market cooling markedly any time soon, nor consumer spending really dropping off. Therefore inflation is at the moment looking like being stronger for longer.
Now everybody’s heading off for summer. And it is three months till the RBNZ next has a scheduled OCR review (on February 22, 2023). Given the circumstances we currently face - with no definitive sign inflation is coming under control - this break is too long.
At least the RBNZ will have plenty of information to chew on when it gets down to looking at the OCR again in late February. By that time it will have seen both the December quarter inflation and labour market figures and the September quarter GDP data.
How those figures are looking - particularly obviously the inflation and labour market figures - will be a key determinant in ‘what comes next’. If there is some sign of cooling then the RBNZ will be able to back off a bit and maybe go into wait and see mode.
If there is scant sign of cooling then we are probably all in a very small boat heading down a fast moving waterway without means of steering.
Governor Orr talks a lot about ‘least regrets’. Clearly the path of least regret the central bank has chosen now is to run the risk that this last OCR hike of 2022 will be the proverbial straw that breaks the camel’s back.
As plenty of economists have remarked, the risk that the RBNZ’s going to flatten the economy increases the higher the OCR is raised.
The huge difficulty is that increases in the OCR don’t have an immediate impact, so, it’s pretty hard to tell looking at the economy today whether enough hiking has been done. The RBNZ will know better in six to 12 months just how much of an impact the OCR hikes to date have really had. But that could be too late.
The trouble is, if interest rates are just pushed up a little - and it turns out in six to 12 months time that this really hasn’t had much of an impact, the central bank is then stuck in a situation where it’s not making headway with actual levels of inflation, while inflation expectations (which of course generate future inflation) are rampant.
So, the path of least regret is to really try to hit the economy with everything now - and hope you don’t break it.
As far as the RBNZ is concerned inflation must be killed. Whether that will also kill the economy, we will find out.
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