ANALYSIS: The slightly better-than-expected inflation numbers released this week have strengthened expectations that the Reserve Bank will cut the Official Cash Rate by 0.25% to 3% on August 20. But before anyone gets optimistic about the impact of still slightly falling interest rates on the economy and the housing market, there are two important things to note.
First, mortgage rate cuts did not prevent the 2% decline in house prices seen over the past three months. Business margins are crimped like never before, young and middle-aged Kiwis are upping sticks for Australia, and weeding out continues across all business sectors and especially retailing, residential construction, and hospitality.
As I strongly warned 11 months ago, falling interest rates are not a panacea delivering comfortably high growth in one’s economy and incomes. All that they do is remove a source of restraint. Applying a boost is quite different, and in the absence of a fresh crash of some sort, big additional cuts in interest rates after August 20 are unlikely.
Second, the job of us economists is not just to make forecasts (which usually turn out wrong), and to comment on the latest data. We also need to offer perspective, and the best way to do that is to step back from the day-to-day fray and look at the bigger picture.
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When we do that for inflation, the scene is challenging. The country’s inflation rate has just lifted to 2.7% from a low of 2.2% six months ago. This is within the 1% to 3% target range, so there is no need for great concern.
However, the 2.7% outcome occurred after New Zealand’s economy shrank 1% in the year to March and grew only 1.3% the year before that. Our growth tends to average just over 2.5% and stronger growth tends to produce more inflation, not less.
Higher inflation also occurred against a backdrop of rising unemployment, from 3.4% two years ago to 5.1% now; falling net migration flows, from 80,000 a year ago to 15,000; and falling consents for new houses, from 51,000 to 34,000.
There will be some new downward pressure on the rate of inflation over the next two years as recent hikes in food prices are unlikely to be repeated, and some falls may occur. There might even be a slowing of increases in council rates if the Government can exercise control over these local monopolies.
Independent economist Tony Alexander: “Borrowers can reasonably look forward to another 0.25% to 0.5% coming off floating mortgage rates in the next nine months.” Photo / Fiona Goodall
But businesses are indicating to rebuild margins by raising prices once customer flows are much stronger. Monetary policy aims at influencing inflation 18-24 months in the future. In that timeframe, the return of over 2% growth, falling unemployment, slightly rising house prices, and margin rebuilding suggest inflation could easily exceed the current rate of 2.7%.
Borrowers can reasonably look forward to another 0.25% to 0.5% coming off floating mortgage rates in the next nine months and maybe 0.25% off the likes of the one-year fixed rate. But for longer-term fixed rates, the scope for declines from current levels is limited.
Add in upward pressure from the new blowing out of US Federal debt, causing higher medium to long-term interest rates around the world, and we are left with the current situation being almost (but not quite) as good as it gets for borrowers this cycle.
– Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz