The pain of inflation Vs the pain on the economy…
2024 was always going to be the year to make or break the direction of our economy and with the recent OCR announcement, we can get a glimpse into where we might be heading. This situation has been building for a while but 2022 was a stand out year for the economy as inflation hit a 30 year high. Many of us saw this in the cost of living as Kiwis across the nation felt the squeeze as food and housing costs surged.
Should sky high inflation levels have been a surprise to anyone?
Perhaps not if we consider that for the years leading up to this, interest rates around the world were cut to help counter the economic shock of COVID-19 lockdowns. As a result of lower interest rates, borrowing became more affordable and this was not only true for mortgages but for car and personal loans too. This is where we see the debt to income ratios come into effect - More on this in another article soon. Low interest rates and more affordable lending can only continue for so long before a problem unfolds.
The pandemic
In the shadow of the global pandemic and the restrictions on travel that came with it, many households found themselves with a portion of their income still in the bank. Funds that usually would have gone on a family holiday abroad were left unspent. Some saw savings rise as social restrictions meant dinners out or trips away could no longer take place and the ‘daily spend’ declined. More money to spend... How could this turn into a problem? Well this led to people changing their spending habits. Cars were updated in huge numbers, homes were renovated and batches were bought. One of our clients saw a 4000% increase in sales from new customers for their ‘hobby business’. What business? Vintage Basketball Cards. And as spending increased, the inevitable effect on inflation started to creep in and the problem began to unfold.
Consumer spending and inflation
So how does a change in consumer spending have such a knock on effect for inflation? As a general rule, interest rates and inflation are persistently linked. Rising interest rates will curb inflation while the other side of the coin sees falling interest rates accelerating inflation. It is easy to see how this relationship was forged if we consider the balance of supply and demand. With low interest rates, consumers have “more money” to spend. Consumer’s buying power increases resulting in more demand on goods and services, yet the supply will remain the same. This causes a rise in inflation as demand outweighs supply. Unfortunately for New Zealand, this change in spending was going to affect inflation far quicker than the Reserve Bank expected.
Fast forward to today, mortgage rates have been above 7% and Kiwis are struggling big time. On Trade Me, Mortgagee sales are up 35% on last year and the average client still has a mortgage (or at least some of it) under 6%. It’s grim reading and this latest Reserve Bank Announcement confirms they know the game is up. The Official Cash Rate is set to remain restrictive at 5.5% to continue to curb inflation but a statement made by the Monetary Policy Committee noted the risk that interest rate pain may be feeding through to the domestic economy “more strongly than expected”. This sentiment had many economists suspecting rate cuts might be coming sooner than the Reserve Bank had previously suggested.
What does Naked Finance think about the OCR?
In our opinion, New Zealand is not going to get relief until the US drops their rates too. It looks increasingly likely that this will happen twice in 2024 with the FED (Federal Reserve) seeing good (falling) inflation numbers also. And as the economic downturn deepens on home soil, there is a growing consensus that the RBNZ will need to pivot from its current stance later this year. We have already seen banks lower the discounted rates since the OCR announcement which is positive, but larger decreases will still be on the back-burner until October / November we feel.
If you are one of the many feeling the squeeze in this economic downturn, you may benefit from some individual advice on your particular situation. For the most part, as of today we are a little reluctant to push the 6 month rates unless the client is open to a bit more risk, while 12 months terms seem to be the better option for most. The situation is expected to change as we get closer to November so it is important to ensure you are making the right decisions for your financial position.
For personal, tailored advice on your mortgage, reach out to our award winning team at Naked Finance. Liam earned himself a spot in the prestigious 2024 NZ Adviser Top 25 Brokers as chosen by the NZA.
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