Tony Alexander: Making households suffer is only a means to an end, not the nasty goal itself

ANALYSIS: Here’s a quick reminder of how monetary policy is supposed to work when fighting inflation. The Reserve Bank raises interest rates and eventually borrowers, feeling the strain, pull back on their spending, especially for big things like furniture and cars as well as new and used houses. The negative commentary surrounding this impact may make people without mortgages also cautious with what they do, and they also cut their spending.

That is the stage we are well into now, with some recent fresh declines in consumer spending and confidence measures telling us that the pain is probably where the Reserve Bank wants it to be.

But making households suffer is only a means to an end, not the nasty goal itself. What the Reserve Bank needs to see is businesses so concerned about the outlook for their sales that they pull back from raising their selling prices. They might either accept compressed margins or seek cost savings – which is also where we are at with job layoffs occurring.

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But are we yet at the capitulation point for businesses whereby they are in fact signalling they have lost all hope in their ability to raise prices? No, and that is a big problem. We are getting the spending weakness, falling business sentiment, plans to lay people off and cut spending. But still businesses doggedly plan raising their prices and until that changes there will be no easing of monetary policy and no recovery in the housing market.

How do we know businesses still plan to jack their prices up? From the ANZ’s monthly Business Outlook Survey. On average over the period when inflation averaged just above 2% in New Zealand, from 1992 to 2020, the net proportion of businesses saying they planned to increase their prices in the coming year was 25%.

Where are we now? 47%. This gauge has been stuck close to twice the average level for a year now and in fact it has just risen from 45% in March.

This development alongside renewed worries offshore about inflation due to labour market strength, and the still-high core inflation contained in the recent Consumers Price Index released from Statistics NZ, tells borrowers not to be optimistic about May 22. That is when the Reserve Bank next review their cash rate and also release a new set of updated economic forecasts.

Independent economist Tony Alexander: "For borrowers the outlook remains one of mortgage rates staying very close to current levels until well into the September quarter". Photo / Fiona Goodall

There is little chance that our central bank at that time will say things are tracking so well they are contemplating cutting the Official Cash Rate from 5.5% before their planned date of mid-2025.

In fact, they probably also won’t make any pleasing comment at the July 10 review either – partly because the June quarter inflation number will be released a week after that cash rate review.

For borrowers the outlook remains one of mortgage rates staying very close to current levels until well into the September quarter. By then there is a good chance (surely) that businesses will have pulled back their pricing plans and the Reserve Bank can consider turning their attention to the weak state of the economy and give slightly less emphasis to fighting excessive inflation.

With regard to the housing market, the various surveys I run alongside data from the likes of the Real Estate Institute of New Zealand and Stats NZ suggest that conditions are going to be challenging for vendors as we go through winter this year. This is not where I thought we would be and much of the blame can go to the way in which inflation is proving so intransigent both here and offshore.

To put that into context, at the start of this year the financial markets in the United States had factored in six interest rate cuts by the Federal Reserve by the end of 2024. Now, they only expect one. Inflation remains a problem.

- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz