So the Reserve Bank is on hold for now, but still determined to raise interest rates over the next couple of years.
The outbreak of the Delta variant and the return to strict lockdown should have put paid to the insular complacency in the consensus about the economic outlookwhich has taken root at the bank and in financial markets in recent months.
It is a reminder of how precarious the fundamental underpinning of New Zealand's relatively swift recovery — its Covid-free status — has been and will remain, at least until the population is vaccinated.
To be fair, the body of the monetary policy statement, written before the latest outbreak, acknowledges that "The emergence of more contagious variants of Covid-19 illustrates the vulnerability of the economic recovery to further outbreaks".
The monetary policy committee considers fiscal policy — government spending and transfer payments, including the wage subsidy which has just been reinstated — has proven "very effective" in responding to any immediate reduction in demand in the event of viral outbreaks.
It does note, though, that "a monetary policy response may be required if a health-related lockdown has a more enduring impact on inflation and employment". More enduring than what is not specified.
Governor Adrian Orr, in his press conference on Wednesday afternoon, was unswervingly on-message that higher interest rates will be necessary.
Uncertainty is one challenge the bank faces, he acknowledged.
But another is getting people to remember that interest rates are extraordinarily low. The bank reckons a neutral level for the official cash rate – one neither expansionary nor contractionary – is 2 per cent, not its current 0.25 per cent.
People should bear that in mind when considering how much debt to take on, Orr said.
Faced with concerns about the risk of persistent inflation, what can the Reserve Bank do?
It can't do anything about the supply side cost pressures that business faces, like shipping costs, skilled labour shortages or whatever has seen wholesale electricity prices surge.
All it can do is suck spending power out of the economy through higher interest rates, to make it harder for firms facing those costs to pass them on to their customers. They have to take the hit to their bottom lines instead. It is not costless.
The bank says recent economic data suggest demand is robust and the recovery has broadened, despite some weakness persisting in the sectors most exposed to international tourism.
"Household spending and construction activity are at high levels and continue to grow, and business investment is responding to increased demand."
The question is how durable that increased demand will prove to be.
In the March 2021 quarter, the most recent for which we have GDP data, half of the increase in households' spending was funded not by higher incomes, but by a collapse in the proportion of income saved. Of a combined household disposable income of just over $50 billion, all but $200 million was consumed.
Among the effects we might expect of the return to Level 4 lockdown is a blow to consumer confidence and an increase in saving. Who knows how persistent that will prove?
Meanwhile, a fundamental driver of demand growth has been population growth, but lately, not so much. The statisticians reckon that in the June year just passed the population increased 0.6 per cent, compared with an average of 2 per cent over the previous six years when net migration contributed two-thirds of the population increase.
Orr acknowledged that one challenge was getting people to remember that interest rates are extraordinarily low. Photo / 123RF
So the same closed border which has seen the labour market tighten has had offsetting impacts on both sides of the output gap, which is central to an inflation-targeting central bank's calculations. It has curtailed the economy's potential to supply stuff but also throttled back growth in the number of people needing to buy stuff.
Subdued population growth looks likely to persist. The arrival of the Delta variant should stiffen the Government's resolve to reopen the border gingerly. It also seems fairly serious about an immigration policy reset.
Then there is the intangible factor of sentiment, including the wealth effect, where people are willing to spend some of the increase in their wealth. It is one of the main channels the bank has relied on to support the economy.
But now the monetary policy committee warns that house prices are above their sustainable level, heightening the risk of a price correction as supply increases.
A fifth of the 3.3 per cent rise in consumer prices in the latest June year was down to construction costs. Such costs are not part of most households' cost of living, and it is desirable that builders are flat out, given the size of the gap between supply of, and demand for, housing.
Factors the committee expects to weigh on house prices over the medium term include strong house building, slower population growth, changes to tax settings and the ongoing impacts of tighter bank lending rules.
"Rising mortgage rates, as monetary stimulus is reduced, would also constrain house prices to a more sustainable level," it says.
Households are borrowing more relative to their incomes, in part because at the current low interest rates, debt servicing costs are low for new buyers.
"However, if interest rates increase back to a more neutral level, borrowing capacity would be reduced. In this scenario demand to purchase houses at current prices would fall." And with interest rates so low and debt levels so high, the impact of any given increase in interest rates is amplified.
Orr said he could not say how much house prices are above their sustainable level.
"We can talk about corrections but I can't tell you when and by how much, because these are asset prices; they are highly volatile." Dispassionate metrics of sustainability are one thing; psychological factors like fear of missing out are quite another.
But Orr said house prices had fallen in the past, in real terms. In times like these, with CPI inflation low, they could fall in nominal terms.
We can but hope that the Reserve Bank, and its international peers, having inflated the asset bubbles which have seen New Zealand households' combined wealth (in housing equity and financial assets) increase more than 20 per cent in the year to March, will try to deflate them gingerly.
Jabbing those bubbles with a bayonet, so they burst all over everybody and send the wealth effect into reverse, would not help anybody.
