Inflation, Interest Rates and Unemployment

Back

By Ben Pauley

21-07-2022

What a weird and wonderful time we live in. Inflation is at a decade long high, unemployment is at record lows, economic growth is stalling (or rather we’re even seeing contraction), property prices are falling, and ski hotspots are humming!

What is going on?

We get asked this each day from developers, investors, home buyers and even the odd lender! Most of the time I explain to them that I don’t really know, but then I go on to pontificate about what I think.

Inflation

Firstly, inflation. This week we saw figures released for the CPI in the 3 months leading up to June, with inflation running at 7.30%, the highest since 1990. We ran an office sweepstake before the announcement and the picks ranged from 7.10% through to 9.0%, most of us were relieved to see it ‘so low’.

With the RBNZ hiking the OCR, several people have expected to see inflation falter, unfortunately it hasn’t. Between the massive money printing undertaken by the government, record low interest rates and the supply pressure brought on by Covid, inflation is like a rocket ship that is nearing orbit – at some point it may break through and just fly away. The OCR is still well below long term averages, and more importantly, far underneath the rate of inflation. Currently, based on this week’s figures, real rates are negative 4.80%. As long as that continues we are not going to address inflation properly.

My view is that inflation is going to persist for the medium term future, and we will not see it return to normal levels for a long time (years). Some of that is influenced by where I think interest rates are going to go.

Interest Rates

I was speaking with someone yesterday who was picking a 10% 1 year interest rate before the end of the year. His view was that the RBNZ will continue to respond to the inflationary pressures and actively lift rates to combat inflation, bringing it back under control. He may be right, ASB are picking a 75 point hike next time around again and if that continues, the market will price that in and we will edge closer to those numbers.

Where I think there is a gap in thinking, however, is an understanding of the political and social element of the market. In theory, the RBNZ is independent of the government and therefore, any social / political pressure, and are charged with maintaining stable prices and employment (don’t ask me how those work together…). In reality, however, they have all but admitted they are directed and influenced by the government, quasi admitting that they will continue to fund government spending programmes despite their inflationary pressures.

If you couple this with the fact that several mortgages have fixed out on short term rates of 1 – 2 years, and will be refixing at the moment and in the near future at much higher interest rates, there is going to be some serious financial pressure on a lot of households. At 10%, each of us will know people who simply cannot afford their mortgage and all of us can imagine what that will do to house prices. The economic impact of rates so high would be catastrophic to many New Zealanders, and likely cause an almighty recession.

Because of that, I think we will see some real political pressure come on board over the next 6 months to ease the OCR and bring some more stimulatory effects into play. I don’t think Adrian Orr (or myself for that matter) is brave enough to weather the political and social storm that would come from lifting rates so high.

Employment

This brings us to employment and where I think things will get really interesting. Whilst I think over the medium term, we are going to see some easing in interest rates, in the near future I expect these to continue to rise. As I mentioned above, ASB are forecasting another 75 point hike in the OCR and with inflation running as hot as it is, I think we will see the RBNZ push hard until such a time as we really start to see some recessionary data come through (could be soon).

This is having a real impact on people’s pockets. The article linked here gives some detail and I have also written on it before. Someone with a $1M mortgage who is refixing off a 1 year interest rate of 2% and coming off interest only (of which we know some) is seeing their annual payments increase upwards of $45,000.00! That is money that is not being spent in the economy, and is going to impact the service and retail sector. Just as when rates are low and house prices are going up, we see money come into the market and the stimulus effect, when rates rise and house prices fall the opposite happens.

We have been operating in a market with near full employment for a little while now. How many stories have you heard about people struggling to hire staff, mates finding new jobs with bumper pay rises and the labour shortages in NZ? Having recently hired (late last year) myself, I can tell you the market is tough and it has definitely been an employee’s market.

What is changing, however, is the demand for staff. I expect this to soften significantly in the next 6 months as the inflationary and recessionary pressures begin to take hold. Further to that, I expect that with the reduced spending and slowdown in activity, we will begin to see businesses looking at where they can trim costs and staff is going to be an item I think will get a lot of attention.

Because of the tight market as mentioned above, we have seen the average cost of labour grow to an all time high with movements in wages of over 5% for ~23% of the workforce in the March 22 quarter. I have anecdotally heard on more than one occasion that businesses are hiring people on wage and salary rates above what they deem is deserved by the skillset, such is the dearth in availability of prospective employees.

In the final quarter this year, I expect to see the unemployment rates turn up a notch and I would not be surprised at all to see the feared trifecta of rising un-employment, recessionary data and continued inflation. As businesses look internally at where to cut costs to cope with inflation and experience drop in income, they will need to turn to labour as one of the items and I wouldn’t be surprised to see a bit of a reset in the market.

This further underpins my belief that we are going to see some stimulatory behaviour from the RBNZ in 2023 with cuts to interest rates and easing of risk criteria (such as LVR restrictions).

What does this all mean for you?

As always, this is just my opinion-I could very much be wrong and each situation differs. It does mean that you should be engaging with an adviser and having a chat around your situation and putting some thought into what the next 12 – 24 months looks like for you.

If you’re ready to chat, get in touch with us here.

Please read our Disclaimer Statement for more information.