ANALYSIS: The Reserve Bank of New Zealand has just reviewed the Official Cash Rate (OCR) and left it at the 5.5% level it was taken to on May 24. This 5.5% level is well above the pandemic-driven rate of 0.25%, which applied between March 2020 and October 2021, and the 1% level in place just before the pandemic. It is worth remembering perhaps that when the pandemic struck the biggest worry for monetary policy was not how high rates needed to go to contain inflation, but how low they might need to be pushed to try and generate inflation.
In 2019 debate raged here and overseas about deflation and the risk that people would have to pay banks to hold their funds – negative interest rates. Is it likely that when the dust settles after the current surge in inflation and the annual rate is back below 3% come late-2024, that worries about deflation will return? And if so, does this mean the cash rate will again head to 1%?
Nothing can be ruled out, especially when we acknowledge that most inflation and interest rate forecasts and financial market expectations have been wrong since 2007. But there have been some fundamental shifts recently, which suggest come 2025-26, when monetary policy easing is well underway, the cash rate will settle closer to 3.5% than 1%.
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First, although there is currently some deflation in China caused by exceptionally weak economic growth, this situation is unlikely to persist. The eventual return of good growth is likely to see unit costs of production start rising again and this will take us quickly back to the recently developing situation of rising prices for goods made in China as opposed to falling prices, which were such a major factor behind low inflation globally post-GFC.
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Second, as countries fight climate change and transition to non-carbon based transportation and electricity generation, the costs of virtually everything using energy will go up.
Third, as climate change causes damaging weather events, insurance costs will rise for householders, businesses, and governments, as will local authority rates and taxes and generally prices for all goods and services.
Fourth, for geo-strategic reasons some countries are moving away from sourcing goods from China and locating production there. The shift towards more expensive locations will entail slight increases in product prices in the importing countries.
Independent economist Tony Alexander: “There will likely be increased charges levied by governments on their citizens along with extra taxes.” Photo / Fiona Goodall
Fifth, labour markets have structurally tightened up. The transfer of inflation through to wages is likely to be more swift and perhaps larger than in the past simply because of the greater bargaining power which people now have.
Sixth, for years governments have been kicking the debt can down the road as annual budget deficits have been run to gain political acceptance, and the coffers have been emptied to fight shocks like the GFC and pandemic. The need for fiscal restraint and debt reduction is growing, even here in New Zealand, where the Government’s accounts are newly deteriorating – as is the tradition for a Labour government not high in the polls in an election year.
There will likely be increased charges levied by governments on their citizens along with extra taxes. The Prime Minister, for instance, has just revealed consideration was given ahead of this year’s Budget to a wealth tax of 1.5% on assets over $5 million. The signal to get one’s wealth out of the country slowly over time is not strong but it is present, though the logical negative currency impact and extra inflation from this is likely to be spread over a very long period of time.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
