ANALYSIS: Russia’s invasion of Ukraine and the movement of other countries away from buying commodities exported by Russia – especially oil and gas – have resulted in substantial increases in virtually all commodity prices. Petrol prices are rising at the pump with more to come, airfares are likely to increase, food prices go higher, shipping costs potentially to go up even further, and many materials used to make the things our businesses produce look like going up in price.
The inflation outlook around the world for 2022 has deteriorated, and here in New Zealand it now looks like our peak rate will be closer to 7.5% than 6.5% come the middle of this year.
On the basis of this higher inflation outlook some forecasters are increasing their predictions for how high interest rates will go and how quickly they will get there. Such revisions are likely to cause deeper concerns about the extent to which house prices will fall from their peaks in November last year. Already Auckland prices are down about 5% on average.
But there are some important things to keep in mind which help explain why I still view the 2022 housing decline as a correction, not a crash.
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First, inflation this year will be higher than was thought just two weeks ago. But next year it may be lower than expected. That is because the outlook for world growth is deteriorating in response to higher energy prices. Slower growth means lower inflation and forecasts of such will act to limit the extent to which businesses feel they can raise their selling prices without causing a substantial loss of customers.
Second, the time period the Reserve Bank is aiming for when tightening monetary policy is 18 months from now. Their rate changes have almost no impact on inflation in the following year and instead the biggest impact comes after about a year and a half. Come the second half of next year we are likely to see some decline in commodity prices and shipping costs, along with better functioning supply chains.
Economist Tony Alexander: “The inflation outlook around the world for 2022 has deteriorated.” Photo / Fiona Goodall
Third, the main effect the Reserve Bank wants from rising interest rates is weakness in consumer spending – bad times for retailers and the producers of retail goods and services. Already from my monthly Spending Plans survey we can see that consumer spending intentions have collapsed over the past two months.
A net 13% of my 1,202 survey respondents plan to cut spending in the next 3-6 months. This is the weakest result on record and is something which will please the Reserve Bank.
The Bank will also be pleased about the correction in house prices underway from unsustainably high levels. They probably also don’t mind the weeding out which has started in the property development sector and the rise in the NZ dollar in response to higher prices for our export commodities.
Their focus is going to be less on newly restraining household spending and more on discouraging wage earners from demanding higher pay and businesses from increasing their selling prices. Achieving both outcomes may be hard considering the soaring cost of living and rising business costs. But achieving restraint in both areas from now will increasingly become the domain of written and verbal warnings, probably eventually culminating in a warning that unless restraint is shown they will need to throw the economy into recession as they did in 2008.
Back then, however, the Reserve Bank took over three years to get interest rates to painful levels. Lesson learned, they are moving far more quickly this time around and that will limit how high interest rates ultimately need to go.
Despite the higher inflation stemming from Russia’s appalling actions, I’m retaining my view that the peak for floating mortgage rates will be somewhere just below 6.5% and the one year fixed mortgage rate peak near 6% - probably just below and probably around the middle of next year.
- Tony Alexander is an economics commentator and former chief economist for BNZ. Additional commentary from him can be found at www.tonyalexander.nz
