The sting from inflation and monetary policy continues

The sting from inflation and monetary policy continues

Scorpion in the desert

In the United states the Federal Reserve board has just increased their funds rate by 0.25%, so it now sits at a minimum of 4.75% compared with just 0.25% a year ago. There were some thoughts that they might not increase their interest rate because of the recent collapse of three banks in the United states but that would have been a mistake. Problems for these banks were partly driven by the fast speed with which interest rates have increased, but ultimately it comes down to lack of diversification in their depositor base and some extremely bad liquidity management policies within those banks.

The outlook for growth in the United States and to a far lesser degree the rest of the world has deteriorated marginally as a result of the new concerns about banking sector stability.

But it pays to remember that the global financial crisis was driven by bad lending policies into the housing sector. That is not the case this time around and instead the problems have largely been driven by poor depositor management.

The inflation problem still remains.

Labour markets continue to be very tight around the world and that is the case in New Zealand as well. It's true that in sentiment surveys businesses are saying they intend laying off staff and we can see some attrition is starting to appear around the economy. But businesses still rate a lack of employees as the biggest constraint on their ability to increase output and near record proportions of businesses say that both skilled and unskilled labour are hard to find.

The upside of that is that wages growth is likely to remain firm and this will go some way to offsetting the still rapidly rising cost of living. Continuing good job security will also provide a firm level of support in the housing market especially for the first home buyers who, as noted here a couple of months ago, have returned to the market. They are encouraged by large falls in house prices compared with wages rising, lack of competition from investors, ample supply of stock on the market, and feelings that interest rates have peaked.

That is probably the big change in many people's minds as a result of the banking events in the United states. My comment since late last year has been that I am 90% confident we have seen the peaks for fixed mortgage rates in New Zealand. My confidence now sits at 99%. The speed with which new fixed mortgage rates decline from here is likely to be extremely slow. But as people pull back from deep worries about fixed rates approaching 8%, they will start to run numbers in their head again regarding the viability of making a property purchase.

These new calculations almost certainly won't be generous enough to encourage investors back into the market especially as they continue to see their ability to deduct interest expenses get worse as each year passes.

But the flow of first home buyers is likely to continue with an underlying view that banking sector problems are not an issue for the New Zealand economy and are something occurring offshore.

Our central bank’s next review of monetary policy will occur on April 5

It’s highly likely that they will increase the cash rate by 0.25%, which will take it to 5% — and there is a chance that that could be the peak cash rate the cycle. We simply don't know. There remains massive uncertainty regarding where inflation is headed in this unique post-pandemic environment and people need to be careful not to get overly fixated on any particular set of forecasts regarding where interest rates are likely to go.

We are likely to receive more shocks on the upside and downside for inflation and interest rates over the remainder of this year and that is why although most people are gravitating towards fixing for a one year, one should not completely discount having a portion of one’s mortgage interest rate exposure also set for two years.

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