By David Hargreaves
Anybody old enough to remember the 1970s 'oil shock' and the seemingly never ending price rises that accompanied it will have kept shaking their heads in disbelief at the apparent 'death' of inflation.
The Reserve Bank, having spent the past few years reacting with boxers' twitchy reflexes to emerging inflationary pressures that turned out to be just tricks of the light, has given as its 'number 1 priority' in its Statement of Intent covering the next three years to: "Continue to deepen our understanding of the current drivers of low inflation and their consequences for the economy and monetary policy."
What that tells you is that the RBNZ, in its quiet, understated, raised-eyebrow kind of way, has been totally exasperated by its inability to get a handle on inflation (or lack of it) in the 'modern world'.
Toward the end of 2015 the RBNZ, in response to a fall in the value of the Kiwi dollar, came out with some heroic assumptions that this would promote a sharp rise in inflation in the early part of this year. Plenty of people thought it would be wrong, and it was.
Keeping the lid on
Key things that have kept the lid on inflation have been low oil prices and the strength (subsequent to that fall last year) of the New Zealand currency.
On top of such non-controllable factors, Kiwis are obviously getting pretty savvy at importing low inflation from other economies. A demonstration of this was the rush by canny shoppers to take advantage of the British currency's post-Brexit plunge.
The ability to import deflation in such a way, courtesy of internet technology, would appear to be one factor that has caught out the RBNZ's inflation modelling quite badly.
After cutting the Official Cash Rate to a new low of 2% last month the RBNZ said it did not expect CPI inflation to reach the 2% mid-point specified in the Policy Targets Agreement with the Government until the September quarter of 2018, which would imply a sub-target inflation rate for almost seven years. The Bank forecast CPI inflation, which was 0.4% in the June quarter, would not reach the bottom of the bank's 1-3% target range until the December quarter of this year, implying a sub-target-range inflation rate for at least 8 quarters or two years.
Why not spend, spend, spend?
One thing that has been quite hard to understand in the current housing boom is the way in which consumer spending generally in this country doesn't seem to have slipped off its leash in the way it has in past such booms.
Is that about to change, though? And what happens if it does and perhaps is changing as we speak?
Within the essentially very good news story from last week of 3.6% GDP growth were some not necessarily good signs for the future.
House price inflation, strong as it has been, is not a component of our CPI inflation. Therefore the housing market shouldn't at most times come into consideration by the RBNZ when it is setting interest rates. (Though we know it clearly does.) The housing market is generally a 'financial stability' issue while the control of inflation and interest rates come under the RBNZ's 'monetary policy' responsibilities.
Secondary inflation
Where it gets interesting is when the strength of the housing market leads to increases in construction costs and rises in the prices of household goods. This 'secondary inflation' is of course in the CPI and is very much in the realm of the RBNZ's monetary policy gambit.
The GDP figures are showing strength in construction and in household spending. And there are other signs that the dog is being let off the leash. When I took a Sunday flight from Auckland to Nelson last month it seemed every second person on that (full) flight was just coming back from an Asian holiday.
And sure enough the latest travel and migration figures show that last month a record number of Kiwis for an August month had an overseas getaway, with some 235,200 trips, up a whopping 8% on the figure a year ago.
Loosening the purse strings
Perhaps the nationwide loosening of the purse strings that's seemingly occurring is a reaction to the fact that this year the housing boom, which remember was previously largely an Auckland thing, has broadened out to many other parts of the country. The 'wealth effect' of rising house prices encourages people to slip the odd $20,000 here and there on to the top of the mortgage and then spend it. Throw a high kiwi dollar into the mix and there's extra incentives to spend. And the recovering dairy prices are now easing one of the main negatives in the economy.
These are all very tentative signs of future inflation, but I would argue they are the first 'real' signs for a long time. If global oil prices remain depressed and the Kiwi dollar remains high then the rise of these domestic pressures will be barely noticed in the 'headline' figures. But of course the more we depend on these globally-driven deflationary forces, the more vulnerable we become.
It's easy to see why a more relaxed attitude to spending by Kiwis might be coming through. But we have to be careful what we are spending. Putting more money on the house is risky.
Hocking ourselves up
Figures from the RBNZ out earlier this month show that household debt is now running at some 165% of annual household disposable income, which is an all-time high, higher even than in the last housing boom in the mid-2000s.
Now, the ability to service the debt is very comfortable at the moment - courtesy of the real low interest rates. But it wouldn't need much of an upward movement in rates for the levels of comfort to quickly disappear.
It's impossible to pick global trends at the moment, such is the tumult in the world. But if, for example, oil was to pick up in the closing months of this year and if (and these both remain big ifs) the US Federal Reserve was able to get an interest rate hike in the US before the end of the year - with the assumption that this might finally puncture the Kiwi dollar somewhat - then things could start to look quite different here.
Look, let's be clear. For now we have virtually no inflation and an economy rocking along under blue skies. But, the situation will need keeping a very vigilant eye on.
Inflation and rising interest rates just may not be as far away as everybody is tending to think.
15 Comments
There's a low probability of the Fed increasing rates due to the election. Oil is still oversupplied and the price has tumbled a bit. However an OPEC deal may eventually happen, there's just been a lot of posturing lately. They're having a tough time getting agreement to reduce production.
The rest of the article is in-line with what I'm seeing.
"But we have to be careful what we are spending. Putting more money on the house is risky."
Absolutely. You're not rich because your house is worth more and you put it on the mortgage. You are just in more debt. And debt still has to be repaid.
You are only rich when you start to have more actual disposable income and from what I can tell, wages aren't really on a stellar track up. So whilst GDP may be up by 3.6%, wages need to follow suit just to keep up with normal price increases in our bills etc. because we all know those tend to go up no matter what the economic scenario.
Of course those who sold up and moved with plenty of cash in their pockets are flush with cash and spending I'm sure, but really that's a small portion of the population.
Really hope we see some inflation, so the reserve bank can then lifts interest rates, and savers can then get a good return from banks, without having to buy houses or shares. That should then see house prices at least not rise as much, as people will not be able to service as large a mortgage.
The scary thing for me is that with massive house price appreciation, the Christchurch rebuild at full swing,record immigration and record borrowing we are only seeing .7% real GDP per capita.
The last decade has seen growth come through indebtedness on house price rises and immigration not productivity.
Do we think that house prices can continue to rise to keep pace with borrowing to keep this madness going when in Auckland they are so unaffordable no average Aucklanders can afford an average house.
There will be no more investment the minute investors cant make money on their tax free investment. What then do these investors turn to renters and hike rent to give a return? Id suggest many will shortly cut and run. Take the profit before the collapse. Once this starts it could be an avalanche.
I feel as though the housing market is going to crash and even if it doesnt the increasing debt is going to be a huge handbrake on the NZ economy.
When you rely on debt for growth eventually you have to pay. I think the banks know this already and thats why the big banks didnt pass on the full OCR cuts. They have also restricted overseas investors who I guess could cut and run. Theyre doing this themselves without any coercion from the RB.
Its gotten to the point where inflation is not in the hands of the our central bank and the few tools they have seem ineffectual.
Isn't housing excluded from inflation figures? If it was then I suspect real inflation would be significantly higher than it is. It is stupid if it is excluded because we pay hat on houses and they are consumables, in that they depreciate and need more money spending in them to replace parts that get old and need replacing.
Relay the reserve bank has no control, as it is a global problem. They may give the illusion what they are doing is controlling things, but they have no choice to keep lowering the interest rates to stop the nz dollar rising.
Great post mark..... keys government has allowed this huge issue to ballon and now it is a handbrake
Prices up 1/2million under Key. More than all the other leader before him combined. Isnt that alone a crazy thing. This was allowed after the biggest global crash since the 30s..... based on dodgy mortgages .... wow nothibg was learnt at all
New housing has a 4.20% weighting on CPI, it has fallen from 9.87% in 1999.
Existing housing is not included as with all second hand goods.
Now consider most money (57%?) is created when banks lend for mortgages on housing.
Interest rates throttle this, getting feedback from CPI which has the above component of housing.
As long as there is such a disconnect between money supply and the measured inflation outcomes, any tool specifically designed to target inflation by tweaking the supply of money (credit) is not going to work! We now have ample evidence that in modern times, credit growth fuels asset appreciation but not spending. It is another example of the failure of trickle-down economic theory.
"Anybody old enough to remember the 1970s"
Yep lot lot of little things seem to Deja Vu....
Imported inflation, bitching about living wage.. leading to wage inflation.. suppressing the economy.. wages by cheap labour...immigration...
Economics and history works in 7 to 9 yr minor event cycles, around 35 yr more serious, and 70 yr big events.
And these , in particular relate to living memory of those in control not around and inherited memory (stories of depression growing up)
I think we do have a little way to go yet before the proverbial hits the fan (last time was Muldoon wage/price freezes grasping at straws,delaying the inevitable basically resulting in bankrupcy a few yr later)
Yes many of those little signs are appearing between the cracks......again... inducing government local and central self serving bureaucracy and politicians thinking short term and no balls to do hats needed long term.
Last time we had them but Kirk died, Rolling had no balls, and the Douglas super scheme used as a election bribe by Muldoon
Once again,the assertion is made that low inflation is primarily down to a depressed oil price and a high NZ$. This simply does not bear scrutiny. If anyone cares to look at long-term inflation graphs,then it is immediately clear that inflation began falling a long time ago. How long? In NZs case,26 years ago and significantly further back for the US and the UK. The reasons are manifold: the success of inflation targeting,globalisation and its effects on incomes,technology and loss of union bargaining power are perhaps the most powerful forces acting to suppress inflation. In the case of technology, we are only at the beginning of the journey and while it will of course create jobs,many of which we cannot even imagine right now, the signs are that it will destroy,or render obsolete,many more. What is more certain, is that its effects will be deflationary. We will also continue to be more energy efficient.
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