One of the defining characteristics of this post-pandemic period with regard to inflation and interest rates is that surprises for both have tended to be on the high side. That is, more often than not both here in New Zealand and offshore inflation rates have turned out higher than expected. This stems from under-estimating the impact of the extreme easiness of fiscal and monetary policies during the pandemic period.
However, as one who has been around for three and a half decades commenting on the New Zealand economy and observing offshore markets, I’ve learnt that surprises never stay pointing in the one direction. A key aspect of markets is that they are adaptive. If shocks keep coming in one direction, then market participants will assign a high probability to the shocks continuing. That is fairly much where we are now.
Pessimism about inflation around the world is high
Especially in light of much stronger than expected rates of jobs growth in the likes of Australia, the United States, and the United Kingdom. High jobs growth raises the risk of high wages growth, especially in the current environment where productivity rates of improvement have slowed down.
The balance of risks when it comes to assessing shocks and their impact has probably shifted to the downside. That is, fresh news looking bad for inflation is already heavily incorporated into current market expectations and therefore market prices for interest rates. The risk is that inflation numbers now start to come in at slightly lower levels than anticipated and this will produce some declines in wholesale borrowing costs.
This doesn’t mean that our central bank is going to start easing monetary policy anytime soon
Not with the exchange rate weakening, business inflation expectations and price-setting plans still high, and a shortage of staff producing declining productivity (higher costs per unit of output) as businesses pull back from capital spending they desperately need to do, partly because of discontent with government policies and because this is an election year.
But it pays to note that just this week in Australia the monthly annual inflation rate turned out to be a full 0.5% lower than expected at 5.5%. This is quite a forecasting error for a monthly series as important as the CPI and it has had the effect of causing some declines in Australian wholesale interest rates.
Despite this, it's likely Australia's cash rate will need to increase
The cash rate in Australia will probably have to rise by 0.25% for at least two times, which will take the rate to 4.6%. I mention this because our rate in New Zealand is 5.5%. The US rate is 5%, as is the rate set by the Bank of England.
Our central bank tightened monetary policy quickly and has taken the cash rate to a very restrictive level. Other central banks are still catching up to the post-pandemic inflation risks. No further rate rise in New Zealand is likely. The common pick instead is that the next move will be a reduction and that this will likely come towards the middle of next year.
But based on how markets tend to overshoot with their levels of optimism and pessimism, and given the low inflation surprise in Australia, we cannot rule out the first cut in our 5.5% coming quite early in 2024.
That is why for most borrowers the one-year term is likely to be the best choice.
But given the history of poor inflation and therefore interest rate forecasting here and overseas in the past one and a half decades, no-one should feel that they are defying logic by locking their mortgage rate in for 18 or 24 months. These remain very uncertain times which we are living through and each week if not day seems to bring us new information we must throw into the mix to try and see through the post-pandemic fog.
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