Strong growth is a key factor driving higher interest rates

Strong growth is a key factor driving higher interest rates

Seedlings growing in soil

Often, we economists talk about interest rates going up largely in the context of rising inflation which is worrying our central bank. But it pays to remember that while there are some special factors related to Covid which are contributing to higher inflation, the main driver is simply good growth in our economy.

The bounceback in economic activity in New Zealand since the first nationwide lockdown last year has been so strong that the unemployment rate has fallen back to the 4% level it was at when we entered that March – May lockdown.

Looking ahead

There are a great range of factors expected to keep demand for labour strong and in doing so apply extra upward pressure on wages whilst also placing many businesses in a position where they can raise selling prices and lose very few customers.

One key driving force for our economy in the next three years will be improving exports. There is a slowly improving outlook for world growth – which has taken a slight step back for the moment because of the spread of the Delta variant of Covid-19. As world growth improves this tends to push up prices for the many commodities we send overseas such as from the dairy, forestry, fishing, horticultural, and red meat sectors.

Export incomes will also be improved by the eventual relaxation of border controls bringing in foreign tourists and students.

Construction activity in the NZ economy is already strong and set to get firmer

The number of consents issued for new dwellings to be built is running at about 0.9% of the population, which is well above the long-term average of 0.6%. There are many businesses needing new premises to house extra raw materials, plus distribution firms needing space for the many goods we buy online these days.

Speaking of businesses, some big decisions are going to have to be made over the next few years. The availability of labour in New Zealand is poor and set to get worse. Contributing factors include the attractiveness of shifting to Australia to work because of labour shortages over there, the government’s tightening of working visa numbers, and Kiwis leaving to catch up on delayed OEs.

Some older people are also choosing to retire early to live off the surprising jump in their financial and property wealth over the past year.

As businesses compete for limited staff, we will see wages growth accelerate

We will also see many businesses investing in order to boost the productivity of their staff. That will mean new computer systems, premises, machinery, and so on. This capital expenditure is one of the most important drivers of economic growth not so much when it happens but over the years afterwards because of higher productivity.

On top of these factors we have a lot of infrastructure work to be done by central and local government in New Zealand. Plus householders have some extra money in their bank accounts over and above what would have been there without the global pandemic. And the paper wealth of many people has soared as their house and investment property prices have risen beyond all expectations.

Strong growth but limited resources can produce only one thing in an economy – higher inflation. That is why even though some of the factors pushing inflation higher are temporary, at the heart of it all the Reserve Bank still needs to slowdown the pace of growth in demand in our economy to better match growth in the quantity and quality of resources needed to meet that demand. That means higher interest rates.

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