It started out as a juggling act and is now becoming a high wire performance routine.
The Reserve Bank (RBNZ) is being forced into increasingly strenuous efforts to get inflation under control.
And our central bank is now getting to the point where it is needing to look at taking the Official Cash Rate to much loftier levels than it would have hoped.
The bigger the OCR number the more the risks to the economy. And for the RBNZ the inflation-controlling attempt is now that high wire walk as it seeks to achieve the increasingly-difficult-looking task of balancing the need to get inflation down while not wrecking the economy.
It's clear that at the start of this OCR-hiking cycle, in October 2021, the RBNZ had high hopes of quickly knocking the stuffing out of inflation. The intent was that the OCR would not have to be raised too far.
Remember 'considered steps'? That was the RBNZ's code for saying it wouldn't hike the OCR by any bigger increments than 25 basis points at a time. Well, five 50-point hikes later, we know what happened to that.
And now the odds-on favourite pick with the economists for the next OCR hike on November 23 is a 75-point jump. Phew.
I will have much more to say about the specifics of the OCR review closer to the time, but there's plenty of fascinating background to have a look through in the meantime.
Since October 2021 the OCR has been hiked by 325 basis points, taking it from the historic low of 0.25% to a current 3.5%.
That is a HUGE amount of tightening of monetary policy in a very short space of time. But just as huge is the problem that the RBNZ now has.
All that tightening - and it's not yet obvious that the inflation genie has been pushed back into the bottle. It's not obvious at all.
The shock 7.2% CPI inflation figure as of the end of the September quarter has massively knocked confidence that the RBNZ's efforts dampening inflation. The dreaded 'inflation expectations' are awake and roaming.
The results of the RBNZ's latest Survey of Expectations make a significant dent in the central bank's credibility when it comes to the inflation targeting. The survey respondents have clearly been shaken by that shock 7.2% inflation figure.
Adding to the RBNZ's misery were the latest labour market figures, which are even hotter than they looked at first glance.
The unemployment figure, which stayed at 3.3%, would have been well under 3% if it hadn't been for a massive rise in the 'participation rate'.
Wage rises, if we look at the private sector hourly rates, came in at 8.6%, which was hotter than the RBNZ had picked (8.3%) - and the RBNZ's pick was the hottest one there was on the market.
The labour market really has become the ultimate double-edged sword. On the one hand the full employment means mortgage holders should be able to keep paying, even as their monthly repayments get more stratospheric.
On the other hand people are getting pay rises that are helping to combat inflation. We are now even seeing double digit pay rises.
The fact that people are now increasingly seeing high inflation as potentially long-running means that they will continue to seek commensurate pay rises. Their employers will continue to seek price rises that pay for the wage rises.
If people can continue to meet higher costs, and continue to spend money, then the RBNZ may not see the slowdown it wants for longer than it hopes. Indeed, I'm sure it had expected to see some signs of slowdown by now. Really what we've seen is the opposite.
All of which then comes back to the OCR and how high it might need to go.
This is where it really gets tough for the RBNZ. Without real outward signs that the monetary policy tightening so far is 'working' the question becomes does it keep pushing the OCR up and up, or does it 'pause' and assume at some point that it has the OCR high enough to, over time, do the trick?
I think the RBNZ would be very leery about pushing the OCR much higher than 5%. I've always thought that if we see mortgage rates across the board at over 7%, we are in real trouble. The RBNZ's latest Financial Stability Report seems, albeit in dry language, to suggest that too.
At the moment we have a situation where the central bank, having hoped to raise the OCR a little, but not too much, is now faced with possibly needing to raise it 'too high'.
Would it take that risk?
Clearly the RBNZ hoped to knock inflation quickly so those darned 'inflation expectations' didn't start getting away.
Well, they have got away and the RBNZ, it seems to me, really needs to change tack.
A quick knockout now seems unachievable. This might have to be a slow grind.
As said above, I'm not sure the RBNZ wants to push the OCR much above 5%.
So, if it gets to 5% and still doesn't seem to be getting enough traction, what then?
Well, as I say, it might have to be a slow grind.
I admit to flip-flopping on this one.
I had for a long time seen the prospect that the OCR rises would not end up being extreme and that in fact a tanking economy would force the RBNZ to backtrack as early as next year. The economy is thus far showing elephant-like strength.
While some economists are still picking the OCR to start falling by the end of next year, I have to say I now extremely doubt that, unless signs do start to emerge pretty soon that the economy is turning. And when I say pretty soon, I mean over the next month or two. No real sign yet.
What I think becomes more likely is that the RBNZ is going to be forced to park the OCR above 4% for some time in, as I say, a slow grind exercise. But of course this approach will mean that some level of inflated inflation expectations do get built into the public's psyche.
So that will extend the 'grind'.
Without a quick 'knockout' of inflation, what we may get then is that the slow grind only slowly forces the economy into a downturn. I mean, it must happen eventually with ongoing higher interest rates. It's a question of how long it takes.
Central banks around the globe have been hoping that any recession that stems from knocking inflation out quickly will be short and sharp.
But with a slow grind approach instead, the worry is we might end up with a downturn that is pretty drawn out and miserable, like we saw in New Zealand in the early 1990s.
I don't make predictions, so I'm not predicting that. But I would say the risks of a drawn out downturn are increasing by the day as our economy continues to confound the RBNZ's best efforts.
43 Comments
So what you are saying is "It's too late".
Once expectations become embedded, it's pretty nigh impossible to un-bed them without fear of what will happen if they remain.
An answer? Put the OCR up at 10% on the 23rd. Surely, we're all prepared for ongoing rises? Even beings on Mars, know that's going to happen.
Madness, I hear the cry. But it's all about time, as well as price.
It doesn't have to stay there long IF the CPI is then reigned in; if those price increase/wages expectations can be reminded of 'what will happen' if they aren't. 3 months ought to do it - until the Feb review. Then, drop it to a more appropriate level.
On second thought, my first thought was probably right! It's too late.....
Captain Go Soft Go Late Orr has got another 5 years to control the direction of the Ship.
And he is perfectly on Track to fulfil the Prophecies of the Scroll.
"Interest Rates will continue to go Up from here and Stay Up for a Long Time."
"The OCR Forecast Peak Goalposts will continually be Moved Higher and Higher ! "
"10% Interest Rates Next Year, Guaranteed !"
The Prophet must of known this.
Some will need to learn The Bankruptcy Prayer !
I'm expecting a +100 hike in November that they can then use as a "watch and wait" approach over the summer.
The problem then is that we're also about to have our first full tourist season in 3 years, which will paper over a lot of the economic cracks that will be in play. So they may well follow up with another big hike in Feb. Then we will be well and truly ready for the wheels to fall off economically next winter.
I'm expecting a +100 hike in November
I agree this is probably what's needed, but it won't happen. Orr has shown time and time again that he doesn't give to shites what anyone else believes he "should do" and is supremely confident that he knows best and will continue the slow and steady approach. A pat on the back from Robbo and 5 more years is just going to convince him even more that he is doing a fantastic job.
And it’s all just a huge own goal. Plenty of people have been pointing out the folly, for well over a year, of the RBNZ insisting on keeping “emergency ocr” settings in place well after it was clear the “worst case” economic impacts of covid did not eventuate.
ah well I’m sure those in charge will recognise these errors and refuse to reappoint those who displayed complete incompetence.
Oh wait
So for tightening to work, we have to have a bout of living costs NOT matched by a round of pay increases.
Or a decrease in real wages, with which people need to use to pay increasing mortgage payments.
I'm starting to feel we're on a real knife edge here. The comparison to the 1990s is correct. We run the very real risk of an economy no one can afford to spend anything on but the basics, but made worse by fear of even further living cost pain. So the people who want to spend can't and the people who can spend won't.
Reducing foot traffic in shopping malls will the first horseman of the stagflation apocalypse. Then it'll be quieter roads. Spending data will not reflect this, as people will be spending more and more to cover the basics.
" I've always thought that if we see mortgage rates across the board at over 7%, we are in real trouble"
If wages are still rising, spending is continuing unabated, unemployment remains at record lows, and non tradable inflation remains high what exactly do you mean by "in trouble". We are in more trouble if effective measures are not introduced. Lending rates were in the 8-9% when I bought my first home in 2005 and NZ was not in trouble then either. If the OCR remains below inflation it is, in relative terms stimulatory and is not as effective in reducing demand. If behaviour truly needs to change then a rise that is not priced in would be preferable - 100bps.
Housing will be collateral damage, but as discussed on this site there are many reasons to want a significant correction and to quote Spock, "the needs of the many outweigh the needs of the few". Before I get castigated for throwing recent FHB's under the bus who bought last year I have a significant mortgage that will need refixing in 2023 so I will be under the bus too.
Before I get castigated for throwing recent FHB's under the bus who bought last year I have a significant mortgage that will need refixing in 2023 so I will be under the bus too.
If you bought your first home in 2005 you will be playing with a lot more equity and have benefited from the madness that got us to this point.
When I was saving for our first house, the huge blowouts in house prices were apparently a case of young Kiwis spending too much on iPhones or cafe breakfasts, and not a structural housing or market issue. Now that people have made their gains, cashed out, suddenly there was a problem the whole time and welp, guess who's just in the wrong place, wrong time again?
There is huge, huge amounts of debt baked into the system compared to when our OCR was last at 9%. Not to mention the default starting 30 year mortgages to make the monthly repayments look more affordable than they really are. Throw in the ballooning of other living costs and you start to see a perfect storm that we haven't seen since the 1980s/early 1990s.
So we think we here in NZ can beat down inflation when the rest of the world hasnt.
Wont happen anywhere while govts are still throwing trillions of dollars into their economies -which was a key driver in the first place
At least a "hung" govt in the USA might put the brakes on
The RBNZ still has the FLP system operating , whilst raising the OCR ...
... one foot on the accelerator , the other stomping on the brake pedal ...
Little wonder so many people across politics & the financial world are aghast that Orr was given 5 more years : barking madness ...
For the last 2 years, some of the larger consulting shops in Wellington working extensively with public sector clients have been providing quarterly/half-yearly salary reviews to retain its staff. They simply pass on this cost and more as a higher charge-out rate for this staff as demand for services from the sector has continued to grow.
Don't worry about its inflationary effects as this cash-splash will be counterbalanced with the sweet f-all wage increase that the government has offered nurses, GPs and polytech workers this year.
David,
Perhaps you might also like to look at increasing the QT by RBNZ selling more of the LSAP bonds that they hold.
We got into this mess not just through excessive lowering of the OCR but also because of excessive QE. A lot of those funds are sitting in settlement accounts earning the OCR for the banks. If the RBNZ sells more of its bonds then that will create QT and settlement funds will also decline along with that.
Asking the OCR to do all the heavy lifting by itself is problematic.
KeithW
Higher than intended? They where hoping to go negative. They never intended to lift it at all and their reluctance to do so in 2021 will bear the rotten fruit of inflation and bankruptcy at least until 2026. At least Orr will be here with us to go down with the ship.
He will be here for sure. But whilst we all struggle he will be drinking champagne with his banker mates on 800k a year and discussing which bank job they will give him after all this is finished.
Meanwhile arden and robertson will wash their hands off all this. Always deny any part and depart for some cusy hugh paid jobs at the UN.
Sept 21 Interest.co.nz article - "RBNZ indicate it will hike interest rates in small increments..."
“The idea is to take small considered steps as you assess the environment around you. You are walking in the right direction, but slowly in case your assessment changes quickly (are your hosts friends or foes?) In the world of setting monetary policy, this translates to having confidence in the outlook for the economy, and inching in the right direction based on how the economy is likely to evolve."
How things have changed...
The shock 7.2% CPI inflation figure as of the end of the September quarter has massively knocked confidence that the RBNZ's efforts dampening inflation. The dreaded 'inflation expectations' are awake and roaming.
People are noticing the relentless financial inflationary pressure. The time for talking about doing whatever it takes to tame inflation is over, now they must act.
If the only option to combat inflation is to crash the housing market, so be it. Hopefully it won't be necessary, but the longer Orr waits before taking serious tightening action (for example, by increasing the OCR by 100 bps minimum, and immediately stopping the FLP madness), the more likely this scenario is going to be.
If Orr stopped the “flp madness” the banks would blame the government for the next round of problems we will face, national would be crying about some angle on it and say they had pulled the rug from under the economy….wouldn’t they?
the govt, banks and rbnz made a deal at the time
they could have provided no flp funding and no wage support to business and we could all be writing about fifteen percent unemployment this afternoon instead…. perhaps?who knows
when the govt won’t stand by it’s deals then that’s becoming banana republic stuff
my own personal opinion is the days of low interest rates and high asset prices could be over. And it will come back to cashflow and real cash equity. If it’s good you can hold or buy more assets, poor or insolvent then you will sell assets. If it is your only asset then bugger!
Wasn’t it always suppose to be this way?
I wouldn’t trust the National party choosing a rbnz governor….well choosing one that would care about his country before the interest of the banks.
I think National is being lead by a group of pawns, in a much bigger game,who don’t have a clue what a mess we have… all twenty years in the making.
Agreed, simply another indictment of the key error in our way of thinking, if it isn't one, then we go to the other. Let's all read each parties memorandum of policies and vote on policy not people or history, spread the word and we have the power to think differently for a change and better shape NZ's future.
Thanks David. Great article about RBNZ woes.
It would be good to get some opinion on how the government’s continued excessive fiscal stimulus is not helping the situation.
Also why hasn’t more pressure been put on RBNZ to stop its FLP programme? Banks can still get cheap funding until December. This is not helping in its battle to keep inflation under control.
There is simply too much cash in the system & it is affecting society unequally with the poorest being impacted the most.
It might be great for society today to live on a huge amount of borrowed money but when your credit runs out it’s a long way back to profitability.
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