We are now less than one week away from the Reserve Bank’s last review of the official cash rate for 2022 with the next review not coming for three months. That is a big gap and will probably influence some of the commentary which the central bank will supply.
Specifically, there is a good chance that they note the three month period will be quite handy for getting a better feel for the degree of traction which tighter monetary policy has already got on the economy and inflationary pressures.
This is important because the discussion amongst central bankers around the world is shifting away from strong statements regarding the need to get rates higher very quickly, and towards reminding people that monetary policy operates with lags.
The usual lag is about 18 – 24 months between policy starting to tighten and inflation solidly falling away. Given that we are only 13 months along from our first tightening one might feel it is too soon to see the impact and that perhaps helps explain the higher than expected inflation number of mid-October.
Frankly, we were too optimistic in our expectation that inflation would be comfortably sliding away
Having said that, it pays to note something important. While we usually measure monetary policy by the level of and changes in the official cash rate, its impact comes largely through changes in fixed mortgage rates.
Those fixed rates change sometimes a long time before the official cash rate moves because the cost to banks of borrowing money fixed to then lend fixed is based on market expectations of where monetary policy is headed.
Therefore, we have to ask ourselves, when did fixed mortgage rates start rising in New Zealand?
Was it October last year when the official cash rate got lifted from 0.25%? No. The one-year fixed rate was 2.19% in June last year. In July it went to 2.49% and come October it was exactly 1% above the low at 3.19%. The three year rate went from 2.65% in April to 3.94% come October last year.
Monetary policy actually started tightening in a real world sense of imposing restraint on the economy in exactly the middle of 2021. That means we can reasonably expect to see the effects showing through from the start of next year and certainly before mid-2023.
I stress this because interest rates in New Zealand have a history of going up the escalator (slowly) and down the lift shaft (rapidly). When the falls start, they will commence with the medium to long-term fixed rates and our knowledge of monetary policy lags suggests this will start before the middle of next year.
The important one and two year fixed mortgage rates are more closely tied to current and immediately expected official cash rate levels. But they also are likely to be falling come the second half of 2023.
The speed of decline is however unlikely to be as rapid as we have seen in the past. This is because of the unusually high level of job security and the fact that if we have a recession next year (something I consider unlikely), it will be very shallow and not cause a radical and rapid falling away of inflation.
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