About two years ago I wrote an article in which I characterised the interest rate hiking cycle that had been commenced by the Reserve Bank in October 2021 as a monetary policy ‘experiment’.
What I meant was we were sailing uncharted waters. Yes, New Zealand had experienced interest rate hiking cycles before – but never of such a magnitude at such great pace.
My argument was, therefore, that we couldn’t be exactly sure what the consequences would be. I said:
The chances are that these OCR hikes could all 'catch up at once'. And the impact could be far greater than anybody currently anticipates.
If that happens, what then?
The worst case scenario would be an economy grinding to a halt, but with inflation still pervasive.
Well, two years down the track. I stand by what I said then.
Now, yes, the June quarter inflation figures released this week would suggest that inflation IS coming under control, which is great to see. So, the RBNZ would be able to point to the OCR hikes as ‘working’.
But, for me, the jury is still out on the other side of the equation – which is the damage done to the economy.
The 0.2% growth registered in GDP for the March quarter of 2024 followed four out of five quarters of contraction.
June quarter a write off
Economists have already written off the June quarter on the basis of a whole series of diabolical results from high frequency data. So, while the June quarter GDP figures won’t be released till September 19, there’s already widespread expectation the economy will have gone backwards again.
I suspect the decline in GDP in the June quarter might have been a bit worse than the 0.2% figure being banded about by economists.
Assuming the economy did contract in the June quarter, this means we will have seen five quarters out of seven of contraction. That will put the current economic downturn in the same sort of company as the grim days of the late 1980s-early-1990s and the post-Global Financial Crisis period.
As economists have pointed out, on a per capita basis our GDP has already contracted by MORE now than during the post GFC period.
The key question for me in all this is whether what we are seeing of the economy now represents the ‘worst’ of it, or whether there’s more to come.
Those choosing to look on the bright side have switched from earlier prognostications of a ‘soft landing’ to saying that, well, if the downturn is a sharp one then the recovery will be quicker.
However, I go back to the ‘experimental’ nature of the OCR hiking cycle. The really big question is that by now beginning to reverse the interest rate hikes, will this just magically bring things back to life?
Well, the problem as I see it is that we won’t know for a while just how much damage has been done. And that in part is due to the fact that for quite some time the ‘damage’ was not really apparent at all.
Getting bang for its buck
The circumstances surrounding this OCR hiking cycle have been very muddy from the start.
It was rightly pointed out in 2021 that the Reserve Bank would get ‘a lot of bang for its buck’ pretty quickly from rate hikes. That was because at the time well over three quarters of the country’s mortgages were either floating or on fixed terms of a year or less. So, in other words the ‘pain’ from higher rates would be felt relatively quickly. That was in some contrast to the elongated hiking cycle just ahead of the GFC when the RBNZ kept squeezing and squeezing with 25 basis point hikes to the OCR but with little tangible result – because a lot of people had taken longer fixed terms.
However, nothing is straight forward. According to the RBNZ only about a third of Kiwis actually have a mortgage. So, yes, that means the grunt work of monetary policy is being done by about a third of the population.
And while, yes, the about-a-third were fairly quickly exposed to higher interest rates this time around, there were other complicating factors in play.
Remember, one of the key components of this massive global surge in inflation that we’ve seen was the massive stimulus provided to offset the effects of the Covid pandemic.
What we had by 2021 was – and this is a generalisation – a population that had been well supported both on a fiscal level by the Government and at a monetary policy level by the Reserve Bank. So, people were ‘cashed up’. Good savings buffers had been accumulated. With incredibly low interest rates in the 2020-21 period (and they had been historically very low before then anyway), very many mortgage holders were able to get comfortably ahead with their payments.
Then of course there were those people who didn’t have mortgages and so that was all very nice and comfortable and basically continued to be so even as interest rates started going up.
I would contend that all this made it very difficult to gauge the impact of the interest rate rises.
Keeping it under wraps
Outwardly it looked as if ‘nothing was happening’. As I’ve said before, Kiwis are a pretty phlegmatic bunch and aren’t going to shout from the rooftops if their savings buffers are going and they are starting to get into a bit of strife meeting mortgage payments.
By last year what we probably had in this country was a mix of the phlegmatic types getting into strife but suffering in silence, while those without mortgages were probably just sailing along fine anyway.
To go back to the article I wrote in 2022, my the worry was that all the OCR hikes would ‘catch up’ at once. And that appears to be what’s happened now.
So, we have switched rapidly from a situation in which it was not clear what effect the OCR hikes were having to being able to see very clearly that, oh, yes, the OCR hikes have had an impact all right.
From October 2021 when the hiking cycle started the RBNZ raised the OCR by 525 basis points (from 0.25% to 5.50%). The conventional approach might be to raise the OCR in 25 basis point increments. So, that 525 points worth of hiking would have constituted 21 individual hikes if done in that manner. There are seven OCR reviews in a year. It would have taken the RBNZ three years.
Instead, however, the whole lot was hiked in just 12 instalments (in well under two years), including one jumbo-sized 75-point hike in November 2022. So, that November 2022 movement was effectively three hikes in one. How is the RBNZ to actually know at the time that it needs THREE hikes when one might do?
All of which is a way of asking whether our OCR rises might have been well and truly overcooked? And, honestly, we don’t know. Might ultimately an OCR of say 4.0% have done the trick?
Obviously the RBNZ is going to say that the fact that inflation is now retreating points to the success of this hiking cycle.
But, look, if I want to crack a walnut… well, then, a sledgehammer will do the job. Is it necessary though? The OCR is such a blunt weapon, it is really hard to judge if three blows are needed when in reality one might do.
From considered steps to calculated leaps
Just before the RBNZ’s tightening cycle began in 2021 the central bank talked of how it would raise rates in “considered steps”. The upshot was that the hiking would be done gradually and with all due measurement of the consequences along the way. But this approach fairly soon gave way to the calculated leaps approach we ended up seeing – very possibly because that was happening overseas too. But just because ‘everybody’s doing it’ doesn’t necessarily make it right.
Before anybody terms the OCR hiking cycle a “success” in turning back inflation, we need to find out where the economy goes from here.
I talked further up about how the damage was initially being done in the economy without it being immediately noticeable. What seems to have transpired from what I can see is that once the direct impacts on the mortgage holders became very noticeable this has had a kind of psychological flow-on to others. And suddenly it means that even those who can still afford to go out and spend stop doing so. They decide that times are tough and they shouldn’t. And that means businesses find they have no customers and their trade tanks. And they go under and people lose jobs. This is what we are now seeing in a rush. The unemployment figures to be released on August 7 will be very informative. If there’s a big jump (and I suspect there might be) then we could be in trouble.
The real test comes as we see interest rates start to come down. It’s now looking like it will be November at the latest for OCR cuts. And an earlier start date is very possible.
Assessing the damage
If the RBNZ starts to realise that the economy’s rather more damaged than it thought it can of course start to drop the OCR in big chunks as well. What goes up at speed can certainly come down at speed. In the wake of the GFC, for example, we saw the OCR cut on two consecutive occasions by 150 points (a whopping 300 points combined).
So, the RBNZ can accelerate the cutting process if it wants. And with mortgage holders having opted recently for shorter and shorter fixed rate terms (in anticipation of rate cuts) then many should get some relief quite soon.
The big question that follows is whether such mortgage holders are then able to start spending again.
In addition, will the mood in the economy lift sufficiently that those who aren’t financially stressed – but have in any case closed their wallets – start to spend again?
If that is what happens then the RBNZ will claim success.
I have my doubts it will be that easy. But even if there is a good recovery from here, I’m increasingly of a view that we need to find a better way of keeping our economy on track than simply targeting inflation, and doing so with an instrument as blunt and hard to measure as the OCR.
I stick with my earlier view that this particular monetary policy cycle has been an ‘experiment’. And just by knocking inflation back doesn’t mean this experiment has been a ‘success’. There may have been a better way.
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