A few people might have got a bit excited this week seeing the annual inflation rate come in about 0.4% below the 6% anticipated, at 5.6%. But I would advise against expecting an easing of monetary policy from the Reserve Bank anytime soon. The 5.6% rate is still a long way from the target range of 1% - 3%. For all the measures we economists track, the September quarter movement was more than the June quarter increase, and a key driver of inflation has yet to definitively show slowing growth.
Wages make up a very large component of most businesses’ expenses.
The annual rate of growth in private sector wages in the June quarter was 7.7%. This was down from 8.2% a quarter earlier but ahead of 7% the year before with near 2% rises in both the March and June quarters.
Theory tells us that with record net inflows of migrants into New Zealand and businesses showing below average intentions of hiring and saying the ease of finding labour is much better than average, wages growth will slow. But strict adherence to theory and past experience delivered incorrect forecasts of rising inflation after the global financial crisis.
We should recall also that all forecasts made in the first half of 2020 as the pandemic struck proved to be wrong.
And we must remember that the fall recently in the unemployment rate to a low of 3.2% last year delivered tightness in the labour market which none of us were expecting.
What this means is once bitten (actually bitten many times) twice shy.
The Reserve Bank will not take the risk of sending a signal that they are pleased with the inflation outlook and that easing is not far away until they see established a solid record of slowing growth in wages. In fact, they’ll be looking for wages growth heading back to the long-term average of 3.5% before contemplating easing monetary policy.
This then gives us the bad outlook for interest rates.
Real world proof before easing. But there is an alternative scenario where the Reserve Bank gets worried about over-suppressing the economy and perhaps sending inflation too close to 1% - strange as that may seem at the moment.
The NZIER’s Quarterly Survey of Business Opinion has been running since the 1960s and gives the best information available in New Zealand on how much capacity exists in our economy to handle growth without inflation bumping up. Over the past two quarters their measure of capacity utilisation (think of this as the percentage of machinery in use) has fallen to well below average levels.
Historically this has suggested quickly falling inflation. In addition a net 7% of businesses say unskilled labour is easy to find. The average is a net 8% saying it is hard to find. A net 8% have just said skilled labour is hard to find but the average there is 31%. These measures of capacity firmly suggest inflation falling away quickly.
If we add in the weakness in the economy still to come from many borrowers only now rolling off low fixed mortgage rates to ones over 7%, and households almost running out of savings built up in the pandemic, we get downside risks to growth in our economy. Those risks are accentuated by El Nino and the worsening war situation overseas.
The Reserve Bank will not be budging for now.
This is especially so with actual inflation at 5.6% and wages growth data yet to seriously show the pace of increase falling away. But do be aware that there is a scenario whereby they have to ease quickly from some point in 2024 because of the freeing up of capacity in our economy and the worsening economic growth outlook.
That is why hedging one’s bets with perhaps some mixture of 12 – 24 month fixed rates will be the best option for most borrowers at the moment.
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