Summary.   Last month I wrote about the implications for mortgage rates of the country’s rate of inflation (otherwise known as the increase in our cost of living) hitting 4.9%. This is twice what the Reserve Bank was predicting just six months ago and anticipation of some firm tightening of monetary policy over 2022 has seen wholesale borrowing costs rise sharply.

An economy growing beyond its limits

Tony Alexander

Friday 26 November ‘21

These increases in bank borrowing rates have flowed through into mortgage interest rates charged to new customers rising between 1.3% and 1.8%. It was only just over 6 months ago that a borrower could lock in a five-year fixed rate for 2.99%. Now that rate is almost 5%.

It is however not just the high inflation rate (expected soon to reach 6%) that tells us that the economy is growing at an unsustainable pace. There are many other measures and here are a few of them.

The unemployment rate has fallen to an equal record low of 3.4%.

This is well below Treasury’s Budget forecast of 5.3% and it tells us that the labour market is exceptionally tight. In fact, in the NZIER’s Quarterly Survey of Business Opinion 28% of business respondents said that the main reason they cannot increase their output is a shortage of labour. The long-term average is 10%.

More than that, on average 62% of businesses have since 1970 said that a lack of customers is the main reason they cannot produce more. Now, only 25% say that a near-record low exceeded only by a few quarters over 1973/74.

The same survey shows that a record net 71% of businesses are finding it hard to hire skilled labour, and a near-record 53% say unskilled people are hard to find.

These constraints tell us that wages growth is going to accelerate – and that is where one worry about inflation arises from. The last time the unemployment rate was 3.4% was back in 2007 when annual wages growth in the measure I track was running at almost 5%. Currently, that measure is growing only 3.8%. So, upward pressure on inflation from a decent lift in wages growth has yet to occur.

Throw in reports from overseas telling us that supply chain disruptions and high prices for shipping and materials will persist into 2023, and we get a risk that inflation stays cemented at uncomfortably high levels through 2022 and 2023.

At some stage the Reserve Bank will react to the high inflation outlook by aggressively raising interest rates.

They should do so now with a 1% rise in the official cash rate on November 24 – their next review. But amidst concerns about the global pandemic and an eye still far more on maximum employment rather than achieving the 1-3% inflation target, the timing for sharp rate rises looks like being next year and into 2023.

However, as noted above, this doesn’t matter so much when bank mortgage rates are priced off of wholesale borrowing costs which have already jumped sharply in expectation of the Reserve Bank eventually catching up to the new high inflation risk.

Will rate rises rapidly dent house price gains? Eventually yes. But that looks like a situation for autumn perhaps of next year rather than now, given the high levels of FOMO still apparent around the country, and the recent acceleration in price rises.

On average around New Zealand house prices rose by 3.5% in the three months to July. But they have jumped 6% in the three months to October according to the very up to date data from REINZ. Auckland prices rose 4.4% just in October.

For now, the frenzy continues. But the seeds of a slowing are being sown and that will be the main story for next year.

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