Inside Economics: Why should mortgage holders be punished for Iran conflict with higher interest rates?

A: Thanks, Ian, I do love that dismal science line. The more popular version of its origin has it that 18th-century philosopher Thomas Carlyle used it to mock friend Thomas Malthus’ grim prognosis of the human race in his work An Essay on the Principle of Population (spoiler alert: we run out of food and die).

More recently, scholars have pointed to its use in an earlier work by Carlyle, which was seeking to make the case for maintaining slavery in the Caribbean, which is not such a fun anecdote.

Anyway, I guess the phrase has stuck around because it captures the idea that economics can be quite brutal and uncaring. That’s the science bit, I guess. If something works, it works, regardless of how unfair it might be,

But economics is a social science, so any hard and fast rules ought to be pointed at improving our lives, or there isn’t much point to it.

That’s where things like monetary policy get political.

Who suffers?

Anyway, to your main point, I think there is some general agreement that we shouldn’t lift interest rates rapidly in response to supply shocks even if they push inflation to about 3%, the upper threshold of the Reserve Bank’s (RBNZ) target range.

In fact, we’ve already seen the RBNZ ignore inflation at 3.1% for the past few months.

By my reading of the speeches and statements from Governor Anna Breman since the Iran conflict began, the RBNZ is prepared to look through a supply-side inflation shock in the medium term as long as it doesn’t result in the tradeable inflation (caused by high petrol prices) being transmitted to domestic, non-tradeable prices, such as labour costs.

So it is not yet certain that the Official Cash Rate (OCR) will rise in the next few months.

RBNZ Governor Anna Breman is playing a waiting game on any potential OCR hike. Image / NZME

But in the Monetary Policy Review on April 8 there was a specific warning that “any signs of significant second-round inflationary effects or increases in medium-term inflation expectations would require decisive and timely increases in the OCR to re-anchor inflation expectations”.

That’s what the RBNZ will be looking at in the coming months.

Unfortunately, they won’t actually see the full Consumer Price Index data until July 21. The July Monetary Policy Review is on July 8.

That seems a bit crazy to me. Surely, given this is the key piece of data underpinning the RBNZ’s inflation targeting mandate, the two organisations could co-ordinate better than that.

Instead, the RBNZ will have to rely on the more limited Selected Price Index and its own survey of inflation expectations (due May 13) to get a sense of how deeply inflation may be getting embedded.

This issue should be resolved next year when Stats NZ moves to reporting the full CPI index once a month.

Ultimately, this will be a judgment call, and you might have noticed that it seems to have divided economists.

Some – such as ANZ’s chief economist Sharon Zollner – have argued the RBNZ will need to head inflation off early by raising the OCR progressively to 3% with hikes in July, September and October.

Zollner notes the OCR would still be in neutral territory at that point – ie, neither hindering nor stimulating the economy.

But at KiwiBank, the economics team has sided with your line of thinking. Chief economist Jarrod Kerr has made a strong call, arguing that hiking rates in response to the current supply shock would be “reckless”.

Market pricing

Unfortunately for the average Kiwi mortgage holder, the markets seem to be convinced the RBNZ will have to hike sooner, especially after yesterday’s 3.1% annual inflation figure.

Economists had been predicting that we’d see a brief calm before the oil shock storm, with inflation falling back inside the Reserve Bank’s target band (1-3%). It didn’t.

That higher starting point, as we head into the second quarter, post-war inflation storm, saw market pricing firming the odds on an OCR hike as early as May. Odds moved from 25% to 40% on the May hike, with a hike in July now seen as more likely than not.

Hopefully, most mortgage holders will have had the chance to lock in on a relatively low fixed term by the time the first hike comes.

I agree to some extent that higher rates sooner doesn’t seem very fair, particularly for young families with large mortgages.

But as a counter-argument, we only have to look at the damage done to the economy after post-Covid inflation was assumed to be transitory.

That meant mortgage rates had to go even higher than might have been needed to rein it in, something that all borrowers paid dearly for.

The real culprits?

Finally (great letter by the way, so much to unpack), I should probably address your assertion that oil companies are the real culprits here.

I don’t think local fuel companies have any more control over what’s going on than the rest of us.

If nothing else, the local bosses must be dealing with a logistical nightmare.

I think the culprits are the geopolitical powers involved. I’ll let readers apply their own lens on how much blame they attribute to Iran’s brutal regime, Israeli aggression or US presidential incompetence.

But conflict in the Middle East is unfortunately always with us.

My computer tells me there have been 25 wars in the region just in my lifetime (since 1971).

For my money, the sooner we get away from fossil fuel reliance, the better.

But I will leave you with this: the Financial Times this week reported that US oil refiners have emerged “as one of the few winners from the Iran war by reaping large profits from high diesel and jet fuel prices, boosted by their access to cheap North American supplies of crude”.

Price of power back to the grid

Q: Good morning, Liam

I have a question: if electricity is so vital to this country’s welfare, why are people who produce their own electricity paid so little when they sell their surplus to the national grid, which can, in any event, only be done via a limited number of NZ power retailers?

Regards, Neil Horne

A: Hi Neil, good question. I’ve heard this from friends and family who installed solar panels and were disappointed to find the price they get for selling power back to the grid was much lower than the price they pay the power company for power from the grid.

I’ll give you two answers: the one that power company critics would give you and the one that the power companies themselves would give you.

I suspect there are elements of truth to both.

The first and most political answer you’re likely to get is that New Zealand’s “gentailer” industry structure disincentivises the power companies to pay a premium for excess power generated by households.

To put it bluntly, we have a market where the people who buy your surplus electricity are the same people who’d prefer you didn’t generate it.

Higher prices do tend to mean higher profits for the listed power companies (which are half-owned by the Government).

Pricing isn’t just about profit, though. There needs to be an incentive for the power companies to invest in more generation from multiple sources – hydro, solar, wind and geothermal.

In fact, in Australia, they have been having problems because wholesale electricity prices have collapsed in the middle of the day, even turning negative in sunny states (such as South Australia), because there’s so much home-owner-generated solar flooding the grid at once.

That sounds like a good thing, but ultimately, when the price signals that are supposed to attract investment in the new generation are regularly zero or negative for large chunks of the day, the business case for building that firming capacity becomes difficult to make.

You could, of course, make the case for splitting up the companies, separating the generation arm from the retail.

New Zealand First is making that case in the upcoming election.

Okay, back to the question of pricing.

I suspect the power companies would argue one of the reasons for the price differential between what consumers pay and what they pay for power is to do with carrying the costs of infrastructure and the risks of guaranteeing supply, even in dry years and through demand spikes.

Confidence crunch

The latest NZ Institute of Economic Research (NZIER) quarterly survey of economic opinion landed yesterday.

It showed the confidence that had been slowly building for the past year, rapidly unravelling as oil shock gloom took hold in March.

NZIER deputy chief executive Christina Leung says conflict in the Middle East poses a risk to the recovery that had been taking shape in the New Zealand economy late last year. Photo / NZME

The survey, conducted between March 6 and April 10, showed a net 1% of firms expect general economic conditions to improve in the coming months, down from a net 39% in the December quarter.

That’s the lowest level of confidence since late 2024.

More positive was the “firms’ own trading activity” measure, which was flat on a seasonally adjusted basis, a slight improvement from the net 3% of businesses that reported a decline in the previous quarter.

“A breakdown of responses over the survey period shows business sentiment continued to deteriorate as the US-Israeli conflict with Iran escalated and the Strait of Hormuz was closed,” said NZIER deputy chief executive Christina Leung.

“Although firms’ domestic trading activity remained stable in the March quarter, the ongoing US-Israel war against Iran poses a risk to the fragile recovery that had been taking shape in the New Zealand economy late last year.”

The building sector was the gloomiest, Leung said.

A net 28% of the building sector firms surveyed expected a deterioration in the general economic outlook over the coming months.

In contrast, manufacturing remained the most upbeat sector surveyed, with a net 34% of manufacturers expecting an improvement in general economic conditions over the coming months.

“This optimism appears to have been supported in particular by stronger export demand in the March quarter,” Leung said.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.