Going Up, Going Down

Economist Cameron Bagrie takes a good, hard look at New Zealand and how we’re going as a nation.

Going Up

Inflationary pressures are on the up. Inflation undershot expectations for a long time, staying below 2 per cent, but it’s now risen to 4.9 per cent, driven by factors like petrol prices, but also by an underlying persistent element, which is what you get with a hot economy. The Reserve Bank’s mandate is to see the highest sustainable employment, and 2 per cent inflation in the medium term. It’s overachieved (a good thing) but now it risks missing its targets if it doesn’t cool the economy down. It’s moving down from partypopper to party-pooper.

Going Down

The economy remains vibrant. The unemployment rate has fallen back to pre-Covid levels and is at 4 per cent, a level I consider below maximum sustainable employment.

Oh, the OCR!

The Reserve Bank has lifted the Official Cash Rate (OCR) and has warned there’s more to come in 2022. The good times were simply too good, and demand across the country exceeds supply, putting pressure on inflation. The first port of call is returning the OCR to neutral, which is where the Reserve Bank neither has the foot on the accelerator nor the brake. That would be around 2 per cent. That’s 175 basis points above the OCR trough of 0.25 per cent. What does this mean for you? That will likely take a one-year fixed mortgage rate well above 4 per cent. They have already moved in that direction.

Alphabet soup

What will be the shape of the recovery when we eventually emerge from lockdown? In 2020, that pent-up demand and policy stimulus drove a sharp uplift and a V-shaped bounce. That was then, this is now. Eliminating Covid was never going to work. Now the hard yakka starts, working out how to deal with it. Higher vaccine rates are critical, but people will behave differently in an environment where Covid is endemic. The bounce this time around is likely to be far more muted and look like a U. The Reserve Bank says: “There will be longer term implications for economic activity both domestically and internationally from the pandemic…. with pressure on demand and supply.”

\ 6.4%

Bumpy road ahead

The International Monetary Fund (IMF) says the global economy is entering a phase of inflationary risk and has called on central banks to be “very, very vigilant”. We could see many other central banks increasing interest rates soon, too. There are some warning signs within China’s property sector – and energy prices are climbing.

Didn’t you get the memo?

The Reserve Bank has called house prices “unsustainable”. Crazy prices are testing both the limits of economic valuation and society’s patience. Economic circumstances have changed. Interest rates are moving up. Housing supply is rising rapidly, with a record number of building consents issued in the past year. Tax settings have shifted, and there are tighter bank lending rules. But the housing market is yet to get the memo, with Real Estate Institute of New Zealand figures for September reporting a 2 per cent monthly rise in house prices and 6.4 per cent in the past quarter.

Stags, slugs and grumps

The International Monetary Fund recently trimmed its global growth forecasts and raised its inflation projections. Some people are using the phrase ‘stagflation’, or economic stagnation because supply issues hold back the global economy with rising costs. That looks a step to far. I prefer the phrase ‘slugflation’. Slugflation is my word for firms being slugged with economic challenges, including supply-chain issues, Covid, government policy, rising costs and inflation. It will be followed by ‘grumpflation’ as the inflationary thief dilutes your buying power, if wages struggle to keep pace with living costs – including rents, which are rising sharply.

Home loans will cost you more

Households have benefited from lower interest rates, which has put them in a strong position with a low debt-servicing burden overall. But interest rates are going up. A modest rise in interest rates – a return to neutral levels – is likely to see household’s overall debt payments as a share of your income rise from 5.9 per cent to more than 8 per cent of income. A 300-percentage point rise in interest rates suggests a debt servicing ratio of more than 10 per cent. The average since 1999 has been 9.4 per cent. A lot of households have no debt, though, so these figures mask the hit on households with debt. With mortgage rates possibly doubling, some highly mortgaged households are likely to be vulnerable.

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