Reserve Bank Governor Adrian Orr during his Monetary Policy Statement press conference. Photo / Mark Mitchell
Reserve Bank Governor Adrian Orr during his Monetary Policy Statement press conference. Photo / Mark Mitchell
OPINION
Business and consumer confidence are on the up, inflation is on the wane and there are some serious signs of market optimism breaking out around the world.
So brace yourself, things are about to get ugly.
Sorry, economics is a dismal science I know. I do remain optimistic thatthe world’s central bankers can manage something that might be called a “soft landing” from this post-pandemic economic cycle.
But as last week’s Reserve Bank Monetary Policy Statement reminded us, we need to be careful that relief about a falling inflation rate doesn’t overshadow the flip side of that equation - growth is stalling.
There is some very simple logic to this. A downturn is baked into the recipe for recovery.
Economists have been telling us for months that the toughest bit of the recovery was scheduled for the last quarter of 2023 and first quarter of 2024.
That’s because the downward pressure that higher interest rates apply to the economy takes months to bite (or transmit, as central bankers prefer to say).
So now here we are. It’s summer, the holidays are coming and it would be easy to ignore what’s going on at a macro-economic level.
Reserve Bank Governor Adrian Orr did his best to warn us last week, though.
The RBNZ forecast that rates are likely to be on hold for all of 2024 at least and possibly through to the second half of 2025.
Not all economists buy this. Some of it may be tough talk from the RBNZ to push back against overly optimistic market moves of the past few weeks.
Bear in mind that the economists who think we’ll get rates cuts sooner are actually the pessimists. They’re betting the economy will turn down harder and sooner than the RBNZ forecasts.
Who’s right? Who knows?
But the logic for the RBNZ’s thinking was underpinned by some fresh research it released as a special topic buried in last week’s monetary policy statement.
In a section titled “Monetary policy transmission lags”,the RBNZdelivered a freshwarning about how long it takes for higher interest rates to bite.
The research involved a range of “channels” for transmission and different models for the pace at which the impact flows through these channels.
It also involved the word “endogeneity”.
“Monetary policy transmission to the real economy and inflation is complex,” the RBNZ said.
I’ll take them at their word on that.
But the upshot was a warning that it could take as many as “nine quarters” (or 27 months) for the full effect of higher rates to flow through to street level.
The RBNZ started lifting rates in October 2021, so there’s no question we are now into the territory where tighter monetary policy is working its dark magic.
Nobody who has re-fixed their mortgage in the past 18 months would question that.
But there are further lags to consider. It begins when mortgage holders start feeling the higher rates in their back pocket, that has to flow through to their spending decisions, onto the profits of the businesses that rely on that spending, and then to the really tough stuff like higher unemployment.
It is sobering to consider that the impact of the last hike, in May (taking the rate to its current level at 5.5 per cent), might not be fully done with its hit to the economy until August 2025.
The Reserve Bank worries that a housing market uptick may keep inflation higher for longer. Picture / Dean Purcell
One place where we can see that lag effect is in Centrix credit data.
There were 19,200 mortgage accounts past due in October, up 25 per cent year-on-year. The number of people facing serious debt distress is creeping slowly and steadily upwards.
Of course, those raw numbers are a bit less shocking if you put them into historical context. We are actually only approaching the levels we last saw in 2018.
But if we apply the RBNZ’s logic, then those levels will likely keep rising for another 18 months. That’s more than enough time for debt distress to reach levels that do damage to the broader economy.
At least it seems unlikely we’ll test the grim heights we did in the wake of the Global Financial Crisis.
For starters, the global stuff is generally looking better than the local stuff.
The inflation fight looks to be further advanced in the US and Europe. If international borrowing costs keep falling then local borrowers may well see some relief sooner than current RBNZ forecasts.
China’s economic growth remains subdued and is actually battling deflation. It’s hard to see how that won’t aid in sucking inflation from the rest of the world.
Commodity traders are so sure that the global economy will continue to slow in the coming months that oil prices fell last week, even after OPEC cut production levels.
Let’s end on a mildly optimistic note.
It is, as they say, darkest before the dawn. Businesses and consumers retain faith that the cycle is turning and they can afford to look through the worst of this and focus on lower rates and more opportunities ahead.
A strong, positive economic message from the new Government and the reassuring tick of an ever lower inflation rate should be able to keep collective heads up even as growth stalls and unemployment rises.
A caveat to the slow, grinding handbrake of higher rates is the power of public sentiment. And that has a habit of turning much faster.
