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.
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.