Rising global inflation risks

Young woman in supermarket

Two weeks ago, I wrote about the Reserve Bank publishing a set of forecasts showing they anticipate raising their official cash rate by 1.5% starting just after the middle of next year. My belief is that they could have to move sooner than that and the extent of rate rises could be closer to 2.5% than 1.5%.

But to say that there is considerable uncertainty regarding where interest rates will go would be quite an understatement. History tells us that ahead of the 2008-09 Global Financial Crisis we economists always under-predicted how high interest rates would need to go each cycle. But after the GFC we consistently over-predicted rate rises.

At this stage we don’t know in what direction our errors will lie. On the side of 2.5% being too much of a forecast for rate rises we have the absence of any sign as yet that wages growth is lifting around the world and in NZ despite worsening shortages of labour. Plus, there is the easy ability of people to find alternatives to products going up in price by shopping online.

But on the side arguing that predicting a 2.5% rise is too optimistic we have the massive money printing operations of central banks in the past 15 months, large deficits being run by governments, plus worsening supply chain problems which are causing many business inputs to rise rapidly in price.

What’s happening elsewhere in the world?

For now, central banks are saying that they believe factors which have pushed the rate of inflation in the United States to 5% and in China to 9% for one measure will be temporary. But the longer the period of price rises from supply chain disruptions goes on the greater the chance that people lift their inflation expectations and underlying inflation starts getting cemented at levels higher than the authorities are comfortable with.

And then there is perhaps the biggest factor of all clouding the outlook – and it is not covid. Central banks have said they plan to deliberately let inflation go above their 2% inflation targets for a while to make sure that the risk of deflation which they had been fighting since 2009 does not come back again.

The central banks in the likes of Australia and the US are promising that they won’t raise their interest rates until 2024 – two years after rate rises are expected to commence in New Zealand. But waiting that long is a highly risky strategy and there is a rising chance that at some stage next year they capitulate to inflation concerns and signal rate rises far earlier than that.

This is where rate uncertainty really comes from

It also means that if one is considering how to manage one’s exposure to interest rate changes in coming years it would be very unwise to bet everything on a particular set of forecasts for mortgage interest rates in New Zealand proving correct.

That brings an implication in turn that for most borrowers we have probably reached the point where more focus needs to be given to simply spreading risk and buying time for any uncertain rate changes to be adjusted to. For most borrowers we have probably reached the point where spreading one’s mortgage over a range of fixed rate terms has become the optimal thing to do.

Up until recently my well-publicised preference was for fixing everything for five years at 2.99%. But now that interest rate typically sits at 3.69% and higher while competition has encouraged banks to cut their one-year fixed rates from 2.29% to around 2.19% for many.

The jump from one year to five years has lifted from 0.7% to about 1.5% and it is now a big ask to suggest people fix most of their mortgage for that long period of time.

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How does this impact me?