Our Reserve Bank essentially has two weapons when it comes to suppressing inflationary pressures in the economy. The main weapon is the official cash rate. When the Reserve Bank wants people to pull back on their spending and businesses to lose their ability to easily increase prices without losing customers, they push the official cash rate higher.
On November 23 the cash rate was increased from 0.75% to 4.25% and the Reserve Bank projected that the peak will be 5.5%, likely to be reached early in April next year. On the basis of that monetary policy tightening, banks are engaging in a round of fixed interest rate increases of about 0.5%.
The other weapon at the Reserve Bank’s disposal is the words that it uses.
This weapon was very effectively used a week ago. The Reserve Bank predicted recession for next year and warned that it needs a recession and the unemployment rate rising from 3.3% to 5.7% in order to feel confident that inflation will comfortably go back towards 2%.
Since then, mainstream and social media have been filled with many negative comments about people’s personal financial situation and the risk of losing one’s job. This is quite depressing, but it is likely to please the Reserve Bank because the more that people live in fear and cut back their spending the less they actually have to increase interest rates in order to achieve the same thing.
An interesting thing to consider is this. It has taken over a year for the Reserve Bank to use its second weapon and in hindsight they are likely to view that delay as a mistake. Why? Because as noted here two weeks ago it takes about 18 months after interest rates have increased for disinflationary pressures to appear. Fixed mortgage rates started rising in the middle of last year so we can expect very soon now to see those disinflationary pressures.
In fact, maybe we just have, in the form of the ANZ monthly Business Outlook survey. The survey has revealed a record high level of expectations that house building will decline, a rise in business pessimism back to where it was four months ago, and the most negative levels of employment and capital spending intentions since late 2020. The survey unequivocally shows that the economy is slowing down and inflationary pressures are easing.
But the important point to note is this. Almost all of the responses in the monthly survey came in before November 23. We now have a new risk on the table. This is the risk that the Reserve Bank is tightening monetary policy too much. If they do, then that would be consistent with their history of loosening too much and tightening too much a number of times previously.
What does it mean for the housing market?
I can already see from my monthly survey of real estate agents that the most recent monetary policy tightening has caused both investors and first home buyers to step back from the market again. I remain of the view that house prices will edge lower but at a slower pace than was happening earlier this year. I also still have the view that the market will start to turn around in about the middle of 2023.
But the clear risk is that the level of prices and turnover surprise on the weak side over summer and through autumn. Keep in mind however that with the official cash rate set to reach the peak of 5.5% in the first week of April we are now probably very close to the peaks in fixed mortgage rates if not there already.
This doesn't mean fresh buyers will be coming along anytime soon. But it does mean that once we get towards March and concerns are much greater about the Reserve Bank having over-tightened, we could see a general conclusion that interest rates have peaked and that they will be edging lower over the second half of 2023.
Clearly, these are very uncertain times we continue to live through. But with good support from high job security, good demand for our exports, rapidly rising tourist numbers, and better than expected net migration flows, once we get through the next few months 2023 might not seem as bad as people are currently thinking - keeping in mind that having people highly pessimistic at the moment is exactly what the Reserve Bank intended to happen as a result of its comments and forecasts last week.
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