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There is still plenty of Covid pain to come


ANALYSIS: Two weeks ago the Department of Prime Minister and Cabinet released a survey showing that more than half the country is happy to keep the borders to New Zealand shut, while over 90 per cent thought that life was not going to go back to the way things were pre-Covid.

The research, dated June 16, said its goal was to “understand how to keep New Zealanders engaged with the collective mission – unite against Covid-19.”

“It’s good news the public recognise that New Zealand is entering a new phase and the vaccine will not be a silver bullet when it comes to moving on from the pandemic,” DPMC deputy chief executive Cheryl Barnes said in a statement accompanying the release of the research.

Job done then. The public doesn’t expect things to go back to normal and more than half are happy with fortress New Zealand. Let’s keep things as they are.

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But as the shock inflation figure of 3.3 per cent released on Friday made clear, the comparative success of New Zealand’s Covid response – measured in lack of deaths, a relatively free and open economy and a strong recovery growth rate – has come at a cost.

House prices are reaching record highs in nearly every region


House prices are reaching record highs in nearly every region

The Covid response of every nation around the world has come at a cost: be it in lives, loss of individual liberties, reduced economic output. In New Zealand, the costs have been more prosaic: a massive spike in property prices (the median house price has shot up nearly 29 per cent to $820,000 in the past year) an overheated housing and residential construction market and a closed border fuelling skills shortages and leaving the economy without the fillip the comparatively high level of pre-Covid migration used to deliver.

Over a year ago when Minister of Finance Grant Robertson was first getting the wage subsidy out the door he started talking about “building back better”. Here was an opportunity to reset the dial and fix up a bunch of things that an ordinary political climate simply would not allow.

Then in October, New Zealanders gave Labour something it hadn’t gained from opposition since 1984 – total power.

Robertson’s goal was the right one, but one that is now bumping up against the inexorable forces of supply and demand.

For many in New Zealand’s property opening democracy, this could signal the first significant cycle of interest rate tightening in their home-owning lives.

Rewind to the global financial crisis: Between June 2008 and April 2009, the Reserve Bank’s official cash rate was slashed by then governor Alan Bollard, from 8.25 per cent to 2.5 per cent. It then hovered between 2.5 and 3 per cent until 2011, settling at 2.5 per cent until the start of 2014.

At that point in time the then new RBNZ Governor Graeme Wheeler began to ratchet rates up again getting them back to 3.5 per cent by mid-2015.

Since that short tightening however, the Reserve Bank’s interest rate has only gone one way: down, hitting a record low 0.25 per cent in March 2020. This, combined with the Reserve bank’s Large Scale Asset Purchase (LSAP) programme which has effectively seen the Reserve Bank print money to keep longer term interest rates down, is what current Governor Adrian Orr called “least regrets”.

Reserve Bank Governor Adrian Orr during a press conference on how much capital banks should hold to avoid risk of failing.

Robert Kitchin/Stuff

Reserve Bank Governor Adrian Orr during a press conference on how much capital banks should hold to avoid risk of failing.

Essentially, for the past 13 years, we have lived in an era of the cheapest money in human history that has actually gotten cheaper. Yet instead of economies bouncing back out of the GFC as one would expect on the back of huge monetary and fiscal stimulus, the cheap money sloshing around the global system seemed to have the opposite effect.

There was a huge inflation in asset prices – houses, art, wine, gold, stocks – as low interest rates prompted investors to look elsewhere for returns. Yet global growth was sluggish and investment in new businesses didn’t take off. New technologies such as Internet, iphones, online shopping and services further increased productivity and drove down prices. All that central bank money didn’t create inflation. All of a sudden, Reserve Banks could and did run very loose monetary policy without the fear of an inflation genie popping out of the bottle.

Indeed in Europe and the US there was evidence of the rise of the ‘zombie firm’, companies being kept alive by ultra-low interest rates that couldn’t service their debt if money cost a more historical normal amount. An analysis by Bloomberg in late 2020 estimated that there was over $US2 trillion worth of debt belonging to zombie firms in the US alone.

In New Zealand and Australia the main job of the modern Reserve Bank is to keep prices stable. This is done in New Zealand through a policy targets agreement where the inflation rate is meant to be maintained between 1 per cent and 3 per cent. In Australia, it’s between 2-3 per cent. These targets were created in an era where double-digit inflation was to be crushed, not in an era where there wasn’t enough. Reserve Bank governors, fearful of undershooting the inflation target, found themselves lowering interest rates to boost inflation!

This time last year, it looked like that would continue. In 2019 Orr was even taking about negative interest rates. Others were asking: should helicopter money be deployed?

That talk went quiet some months ago, and now seems to be completely extinguished.

Not only is inflation back at a 10-year high, but according to BNZ, the pick up is “more than transitory” and could be here to stay; Kiwibank says transitory factors “could easily turn into permanent inflation in the current atypical environment”, while ANZ says that it is “seeing signs that sustained inflation pressures are building underneath all the noise, with the labour market tightening, and firms passing on higher costs to consumers”.

We are suddenly confronted with the reality that real inflation might be back, and reminded that despite all of the monetary alchemy engaged in by the RBNZ and many other central banks around the world, that the chief job of our bank is to keep inflation under control.

Sure there have been other objectives shanghaied into the Policy Targets Agreement such as “maximum sustainable employment” and now the bank has to pay attention to the effect its actions have on house prices, but sound money is the main one.

To drive this point home there is even a video on the RBNZ website featuring the bank’s former chief economist John McDermott called: Inflation, a thief in your wallet.

The upshot for mortgaged households and businesses is that higher interest rates mean less discretionary income, less money for eating out, (domestic) holidays, new furniture and so on. It also reduces the ability of households to borrow against the equity in their houses to do renovations and invest in other things.

In short, if inflation is really on its way back up, the party that has kept New Zealand feeling wealthy during Covid – besides our strong exports of course – could come to a screeching halt. The Reserve Bank will be hoping that the prospect rather than the reality of big rate hikes will cool things off a bit.

The problem this time is that if there is an interest rate induced significant economic cooling, will be that the strong migration will not be there to cushion the blow. Even if the borders were miraculously opened in the next six months and global uptake of the vaccine crushed Covid achieved – a highly unlikely scenario – the Government has signalled that it wants less, not more, immigration.

Labour has had a laser-focus, as should be expected from the political left, on those at the bottom of the heap. It is pouring money into health, has lifted the minimum wage, massively recentralised the industrial relations system and re-empowered unions. It has boosted benefits significantly, making a point in the budget of the fact that the relative cuts to the value of benefits in the 1991 budget has been reversed.

The closed border continues to hamper a source of growth New Zealand has relied on for a long time.


The closed border continues to hamper a source of growth New Zealand has relied on for a long time.

It has also embarked on longer-term…


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