ANALYSIS: A week has gone by since the Reserve Bank surprised the markets by increasing the official cash rate 0.5 percentage points rather than 0.25 as had been widely expected. Since the rate change we have seen a lot of commentary in the media about a bad outlook for the economy, recession, householders about to be stressed with higher interest rates, and things basically looking bad for a long period of time.
This is exactly the sort of discussion the Reserve Bank wants to see. The more pessimistic people feel about the economy and their personal finances the greater will the restraint be on weekly and monthly spending. That will mean a greater reduction in the ability of businesses to increase their selling prices and that will mean lower inflation.
There were certainly be a negative impact on the economy from about $170 billion worth of fixed rate mortgages coming up for renewal over the next 12 months, with people on average seeing their rate rising from perhaps 3.5% to about 6.5% or thereabouts.
There is also a substantial decline in residential construction just starting to get underway and likely to run for the next two to three years. House building is an industry which affects many businesses and people all around the country, so the decline is going to affect the economy’s rate of growth and general sentiment.
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But in some regards there is a slight race against time underway here. As each week goes by, more and more people are going to realise and accept that fixed mortgage rates in New Zealand actually reached their peaks almost three months ago. And more and more people will realise that despite the official cash rate increasing by 1 percentage point since February, bank floating mortgage rates have not gone up at all.
The question is this: will the slowly dawning acceptance of a less than awful interest rates outlook cause some improvement in household spending and an upturn in the housing market before inflation is solidly tracking down towards 2%? Probably not.
We know from the NZIER’s Quarterly Survey of Business Opinion released just before the official cash rate change that business problems in finding skilled and unskilled staff have eased quite a bit over the past three months. This is likely because of the strong improvement in net migration inflows. This change means we can be reasonably confident that the unemployment rate is going to increase over the next 12 to 18 months with a peak somewhere close to and perhaps just above 5%.
Independent economist Tony Alexander: “Rising unemployment will make many people cautious.” Photo / Fiona Goodall
Rising unemployment will make many people cautious. We are also likely to be somewhat hesitant to spend as we head into the general election in October. By the time the underlying economic fundamentals which I track start to offset the negatives and the economy recovers well, the rate of inflation is likely to be comfortably heading back down towards 2%.
These positives include the acceleration in population growth noted above, the return of Chinese tourists next summer, an improvement in world growth expected for 2024, stronger central government infrastructure spending, and a natural cyclical bottoming out of the housing market probably in fact before the election.
But the next three to six months will be interesting. The Reserve Bank has stated it is going to be assessing the economy to see whether the easing of inflation and domestic demand is enough to prevent any further increase in interest rates. It should see what it wants to see as household spending in particular becomes further restrained. That means I anticipate maintaining a positive outlook for borrowers with regard to interest rates. But we live through very uncertain times, so be on the lookout for any unusually strong economic data. It wouldn't actually be useful at this point in the monetary policy cycle.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
