RBA may look to New Zealand for clues on the future of the Australian economy

In the race to get off the economic rollercoaster caused by COVID, Australia’s Pacific neighbors New Zealand are holding the ball firmly in their hands and about six steps ahead.

Key points:

• At 6.9 percent, inflation in New Zealand is the highest in 32 years
• Property prices have fallen about one percent every month since banks started raising interest rates in October 2021
• ANZ chief economist for NZ not worried about recession

After slashing interest rates during COVID, the Reserve Bank of New Zealand (RBNZ) was one of the first to make a reversal and began increasing the official interest rate (OCR) in October 2021.

His first increase was a quarter of a percentage point, with several rate increases of the same size after that.

But it actually picked up in April, up half a percentage point, followed by another double gain in May.

The RBNZ is widely expected to undertake another half a percentage point rate hike later today, at midday AEST.

That would take its OCR from 0.25 percent in September 2021, to 2.5 percent in July.

“There are an awful lot of people who can’t remember the last time the Reserve Bank intentionally slowed the economy to beat inflation,” ANZ chief economist Sharon Zollner told The Business ahead of the decision.

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RBNZ is expected to deliver another hefty rate hike(Kathryn Robinson)

That is precisely what the RBNZ, the Reserve Bank of Australia (RBA) and central banks around the world are trying to do by raising interest rates.

“It’s not a pleasant process, it’s not nearly as fun or as easy to explain as trying to encourage growth,” Zollner says.

New Zealand’s inflation rate of 6.9 percent is about three times its target of between 1 and 3 percent.

That could turn him into a canary in a coal mine, a test case for the RBA to watch out for as it grapples with bringing inflation down from 5.1 percent.

Did the rate increase work?

The Reserve Bank of New Zealand was an outlier when it raised its official interest rate for the first time since the pandemic, in October 2021.(AP)

Residential property prices in New Zealand peaked in November 2021, and a 1.75 percentage point increase in interest rates has seen prices fall nearly 6 percent since then.

“The impact on housing is pretty clear,” Zollner said.

But he warns there is further to fall.

“Given that house prices have risen so strongly, up 50 percent in three years, the declines we’ve seen so far have barely scratched the surface,” he said.

He said house prices would need to fall 30 percent to return to pre-COVID levels.

“Very few people are sitting in homes that are worth less than they are paying for, even fewer in homes that are worth less than the debt they owe,” he said.

Home prices in New Zealand are generally expected to fall by 10 to 15 percent.

ANZ chief economist Sharon Zollner said house prices in New Zealand continued to fall.(provided)

Forecasts are similar for Australian real estate, although rates here have gained a smaller 1.25 percentage point from COVID lows so far, and national average property prices are down just half a percent so far.

Consumer confidence also slipped in New Zealand.

“The decline started maybe before interest rates started to rise, but it’s all part of, from where consumers are sitting, the much higher cost of living,” Zollner said.

“That, of course, centers around necessities like food, gas and mortgage payments and, if you also have debt, it all feels like part of the same pressure on households.”

Ms Zollner said the rate of decline in business confidence in New Zealand had been softer.

“There’s more slippage, not downside, as we’re seeing in consumers,” he said.

“For companies that plan to cut investment, of course interest rates are one of the factors they cite as one of the reasons.”

In Australia, consumer sentiment has fallen every month this year, with the latest reading showing a 3 percent drop in July to around recession levels.

Business confidence in Australia has also slumped, but, as in New Zealand, not as much as consumer sentiment.

Two peas in one pod

Zollner said the RBNZ and RBA are fighting the same battle.

“The problems are quite similar,” he said.

“Inflation is rising very sharply, household confidence is very low, but so far there is no sign of people seriously cutting their spending.

“That’s partly because the labor market is very tight, there’s upward pressure on wages and lots of job openings.”

Australia and New Zealand have both extended periods of closing international borders, exacerbating labor shortages in both countries.

Many economists have now acknowledged that this has contributed to historically low unemployment rates and wage pressures on both sides of the trench.

The risk of moving too far, too quickly in interest rates and triggering a recession is as much as in New Zealand and Australia.

But Ms Zollner said aggressive rate hikes were needed.

“From the position of the Reserve Bank, the most important thing is to hold medium-term inflation expectations and not go back to the 1970s,” he said.

“It would be a shame to cause a recession, but it would be worth it, if that’s what you have to do.

“It’s better to have a regular recession now, because at the end of the day, a recession is inevitable, you might just bring one forward, than to do structural damage to the economy by letting inflation get really ingrained.”

The RBA will no doubt be watching the RBNZ closely and how its rate hike impacts the economy there, as it considers its next move here.

“As evidence increases that it [lifting the cash rate] really working and the economy is slowing down, that people are starting to lose their jobs, of course losing confidence, so you would expect the debate about whether the Reserve Bank is doing the right thing to get louder,” Zollner said.

‘You have one job’

Zollner said the biggest lesson Australians could take from New Zealand was taking central bank decisions.

“Don’t underestimate their absolute determination to tackle inflation,” he said.

“This scenario is the reason central banks were made independent, so they’re going to keep their feet in the throat of the economy long enough to make sure inflation is dead.”

He added that as consumers and businesses cope with rising costs, the spotlight is firmly planted on the RBNZ, RBA and their peers around the world.

“The entire credibility of the independent central bank’s inflation targeting is at stake,” he said.

“It’s kind of like ‘you have one job’.”

RBA Governor Philip Lowe has repeatedly said the Reserve Bank is “committed to doing what is necessary to ensure that inflation in Australia returns to target over time”.

But perhaps the contest to dampen inflation is one that will make most Australians happy if New Zealand wins.

Posted 7 hours ago7 hours agoTue 12 Jul 2022 at 18:55, updated 1 hour ago1 hour agoWed Jul 13 2022 at 12:55

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