David Hargreaves says the RBNZ needed to send a message to the markets that rampant inflation is its sole priority at the moment; an approach that is made possible by the - for now - buoyant state of the labour market

So, battle is now well and truly joined as the Reserve Bank firmly squares up to our rampant inflation.

To me the Official Cash Rate decision was about two choices for the RBNZ: Either show the market it was dead serious about getting on top of inflation, or take a ‘not too hot, not too cold’ approach and attempt to take the edge off inflation without running the risk of skittling the economy.

It has decided on the former. The dead serious approach. That tells you inflation is the number 1, 2 and 3 priority at the moment.

The RBNZ probably felt it needed to push that message to the financial markets.

Economists, commentors and other market participants were very sharply divided on the size of the hike. It’s been a while since I recall opinion being so divided on what the best course of action for the RBNZ was.

And roughly speaking, the division was between those who felt there was no option but to go ‘full hawk’ with a big hike and those who felt that there was enough negative momentum already - through things like weakening house prices - to slow inflation, and that to go any harder would risk wrecking the economy.

The thing is though, that ‘going easy’ with a 25 basis point rise in the OCR would likely have - in the estimation of those in the markets - seen wholesale interest rates retreat from where they have been.

I think that realisation, as much as anything else, is what would have prompted the RBNZ to put the foot on the gas.

It actually wants aggressive wholesale interest rate pricing and it wants to see more upward pressure on the mortgage interest rates.  A ‘mere’ 25 basis point OCR hike when the market pricing was indicating more would have sent the wrong signal. A ‘double banger’ 50 basis point move will see the pressure very much on in the wholesale markets.

So therefore mortgage rates will be moving up again too.

As I say, this is an inflation first, second and third strategy, in terms of priorities. Kill the inflation and to hell with the economy - for the moment anyway.

Well, is ‘to hell with the economy’ entirely wise?

Of course not. But this is inflation. There’s no good options here. We have rapidly moved into “what flavour of dead rat would you like to swallow?” territory.

Look, we are talking about a current OCR of 1.5%. Fail to control inflation now and all that happens is that OCR has to go higher later. That could be bad. Very bad.  The RBNZ has reasons to want to avoid that.

In the mid-to-late 2000s the RBNZ was generally considered too late and too passive in pushing back against inflationary pressures.

This resulted in a string of 25bp rises that saw the OCR go all the way up to 8.25%. Yes, 8.25%!

This for a spike that took inflation up to a peak of 5.1% in the September quarter of 2008.

That’s right, JUST 5.1%.

Well, we’ve already hit an annual rate of 5.9% as of December and the odds are pretty good the next annual figure to be unveiled later this month will have a ‘7’ in front of it.

Food price rises are already running at 7.6% as we saw just prior to the RBNZ decision.

To go back to the OCR then, when it was topping out at 8.25% in 2007, floating mortgage rates were around 10.5% and the two-year fixed rates (standard) were about 9.5%.

Wow.

How quickly we forget.

To just indulge in a bit of idle arithmetic with the interest.co.nz mortgage calculator, the February mortgage figures from the RBNZ show that in that month the average sized mortgage for a first home buyer was $566,500.

The FHB at that stage might have been able to get a two-year special fixed rate at 4.25%. Over a 30-year term this would be costing $2787 a month. Not inconsiderable, but doable. Just about.

At 9.5% the same mortgage would cost $4763 a month, or $57,000 a year.

Aaaaaaarrrrrgh.

Instant ruination, unless you were already wealthy enough to probably not need the mortgage in the first place.

Okay, that’s probably a ridiculous example, but I do recall shades of disbelief meeting suggestions less than a year ago that mortgages could soon be heading over 4%. That it was a risk. A lot of people could never see inflation occurring again and therefore never see high interest rates again.

Well, we’ve now got the galloping inflation.

And the RBNZ knows full well that unless it can rein in the inflation, its only recourse is to keep jacking up interest rates.

That 40% house prices surge/bender that we went on from the start of the pandemic in early 2020 to the end of 2021 has left us mightily exposed.

The sheer size of mortgages now is a huge vulnerability.

The RBNZ is very well aware of this. And it is very well aware of not wanting to push interest rates to levels that start to cause undue stress for homeowners.

Loads of houses all being put on the market at the same time in a forced-sale situation would be disastrous, with huge ramifications for the banks and feeding misery into the whole economy.

The big shining light in all this for the RBNZ is the current super-buoyant state of the labour market, with unemployment at just 3.2%. If people stay in work and receiving regular income, they can meet interest payments.

But of course any rises in interest rates - and they are really just getting started now - are going to be felt by mortgage holders as their fixed rates come up for renewal. Omicron is already suppressing spending. Higher mortgage rates will do this and more so. Businesses are already feeling the pinch. There will likely be more trouble ahead for them.  

At the moment the RBNZ can take comfort in our low unemployment levels and therefore just go hammer and tongs at inflation, reasoning that the economy for now can ‘take’ the higher interest rates.

But if we start to see rising unemployment levels and pressure on the housing market as a result, then this all becomes very different. And even more difficult.

The twin perils of a tanking economy and rampant inflation are something we don’t want or need. That’s what the RBNZ is trying to avoid.  It has a job on its hands. A hell of a job.