Liam Dann: Lift-off for interest rates creeps ever closer
OPINION:
Brace yourself. Inflation is coming. Interest rates are about to rise.
Ok, stop me if you’ve heard this one before. I understand the scepticism.
This is at least the third time since the Global Financial Crisis that the experts have been sure we’re on the path to higher rates.
In 2014, the Reserve Bank hiked the official cash rate three times only to see oil prices collapse, deflating the global economy and forcing it to beat an awkward retreat.
In 2010, rates were hiked twice only to be done by the economic impact of the Christchurch Earthquake.
Events happen, and will continue to.
Nothing, as Benjamin Franklin said, is certain but death and taxes.
Markets could collapse, a new Covid variant could put the world back in lockdown.
But on balance, all the signs suggest that it’s happening this time – we need to pay attention.
When we shift to an economy where inflation is a bigger problem than deflation, where rates are rising rather than falling, it will be the most significant, fundamental shift we’ve seen in more than a decade.
It will shake up the way we invest and save, the way we spend and the way we borrow.
House prices … might … even … (gulp) … fall.
In past few weeks we’ve seen increasing evidence of inflation building.
The vaccinated US economy is roaring back to life.
Energy costs have spiked. Crude oil prices are up by 50 per cent so far this year.
Other commodities are on the rise.
That’s good news for our food exporters but it is also ensuring our economy is running hotter than Reserve Bank or Treasury projections.
Then there are all the pandemic constraints adding to the pressure cooker.
Borders are closed and labour is immobile. Shipping is backed up and the cost of moving goods is soaring.
Central banks indicated early on in the pandemic that they would hold rates at record lows and look through inflation on the assumption that it was a short-term, pandemic phenomenon.
A lot of this is playing out just as they predicted.
But saying you’ll look through it is one thing.
Actually looking through it as the pressure piles on and the world panics? That’s another thing.
That’s like telling your kids they won’t be getting an ice-cream before you get to the dairy.
When you’re at the counter juggling the eftpos machine and the milk, it’s suddenly not so easy to say no.
Much of the original inflation debate hung on this issue of whether it would be a temporary or permanent phenomenon.
But defining “temporary” looks increasingly problematic.
On the one hand, the economic recovery is hitting hard and fast, on the other, the impact of the actual virus looks likely to linger for much longer.
If the pandemic takes another full year or 18 months to recede from the foreground of our lives, then all these logistical supply-side constraints could easily take more than two years to unwind.
Is that a temporary thing? It is certainly long enough for inflation get a firm grip and cause real economic damage.
The trouble with inflation (and deflation for that matter) is it is influenced as much by expectations as by real events.
Once people expect prices and wages to rise that effects their behaviour and this in turn influences real price and wages.
So central bankers, thankfully, aren’t being bloody-minded about their plans to look through temporary inflation.
They can see that the risk profile is changing and are looking to move sooner but slower.
The Reserve Bank has produced forecasts which would see the first hike (from the current record low of 0.25 per cent) as soon as the middle of next year.
Further hikes take us through to a medium-term peak of 1.75 per cent by 2024.
That would only be a return to pre-Covid levels. Rates would still be historically low.
But ongoing economic heat has prompted economists to move their expectations forward.
The market now has odds on the first hike by February.
The latest ANZ Business Outlook survey was heavy with inflation expectation.
It had 84 per cent of businesses saying they expect to raise prices, prompting ANZ’s chief economist Sharon Zollner to talk about an official cash-rate hike as soon as November.
Meanwhile, in the US the Federal Reserve has also blinked, forecasting two hikes in 2023.
Some of its regional chiefs are more bullish, talking openly about hikes next year.
Before we get to rates hikes we’ll see the money supply tighten (and pressure go on retail mortgage rates) as central banks wind down their quantitative easing.
The Reserve Bank, which has been buying government bonds at the rate of $200 million a week, might stop buying them altogether in the coming months, BNZ analysts were tipping last week.
A lot depends on anecdotal evidence for inflation materialising in the data.
We’ll get a our next hard take in two weeks, when Stats NZ’s Consumer Price Index (CPI) for the June quarter is released (July 16).
CPI inflation – which doesn’t include house prices – is currently still just at 1.7 per cent.
That’s below the two per cent mid-point and well within the 1-3 per cent range the RBNZ targets.
In theory it justifies maintaining stimulatory interest-rate settings.
Never mind the theory, if CPI inflation comes in above 2 per cent then hold on to your hats.
It might seem like small rise.
But it will represent a giant leap for the economic outlook.
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