Better economic growth may mean higher interest rates
March’s gross domestic product figures were a surprise to pretty much everyone. The data showed a jump of 1.6 per cent – a much higher level of economic growth than even the most recent forecasts expected.
Economists had predicted an increase of about 0.8 per cent. The Reserve Bank had earlier indicated it expected a fall of 0.6 per cent, which would have meant New Zealand had been through a ‘‘double-dip’’ recession. But instead, household spending was a standout in a surprisingly healthy result – up 5.4 per cent in March, on a seasonally adjusted basis.
If you ignore the post-lockdown bounce last year, that is significantly higher than the previous largest increase of 3.5 per cent in 1988.
But all this news of a much-healthier-thanexpected economy has sparked suggestions that interest rates could soon start to rise in earnest.
But why?
Infometrics chief forecaster Gareth Kiernan says the first thing to consider is why rates are currently so low.
The official cash rate, which is part of what drives banks’ retail rates, is at 0.25 per cent. Not that long ago, that sort of rate would have been hard to imagine. ‘‘The rate was cut to encourage people to spend and businesses to borrow and invest on the basis that we were going to hell in a handbasket,’’ Kiernan says.
Low interest rates, and things such as the Reserve Bank’s Funding for Lending programme, were intended to help keep cheap money flowing into the economy to encourage activity that – it was feared – might not have happened otherwise.
Remember, just under a year ago, we were being told it was likely in a worst-case scenario where Covid pushed unemployment to 18 per cent, house prices could halve.
There would not be many businesses borrowing to invest in that environment.
At that time, the Reserve Bank was forecasting a probable peak in unemployment of 8.1 per cent, which it said would cause house prices to drop by 9 per cent. But it did not happen.
Instead, our unemployment rate is at 4.7 per cent. House prices lifted almost 30 per cent yearon-year last month.
We might not be able to take a holiday in Hawaii but we are spending our money at home and we are pretty good at it.
And so the official cash rate that was set when the Reserve Bank expected a drop in gross domestic product (GDP) does not look so reasonable when GDP bumps up.
‘‘The need for rates to be so low is not really there,’’ Kiernan says.
But can’t we just leave them low?
Households are heavily indebted so any change to interest rates will be felt relatively quickly, ANZ chief economist Sharon Zollner says.
The Reserve Bank is wary of acting too early and having to lower rates again – but also won’t want to leave it too late.
Zollner is in favour of rates being put up pretty much ASAP – because, she says, low rates drive the sort of ‘‘frothy’’ growth in demand that is not healthy when there is nothing happening to help the supply side of the equation.
Covid-19 gave a temporary shock to demand when everyone went into lockdown, Zollner points out, but the fiscal stimulus from the Government filled the gap and things resumed pretty much as normal for consumers when we were able to spend again. The disruption to the supply side has been much longer.
Now, the biggest constraint on many businesses and further economic growth is their ability to deliver, because of things like supply of products, or staff shortages. Costs are rising as they struggle to keep up with the flow of customers.
‘‘If they keep [rates] low, all you are doing is generating a whole lot of demand that is not going to be sustainable,’’ Kiernan says.
Rising costs are a big concern for the Reserve Bank, which is tasked with keeping inflation within its target band of 1 per cent to 3 per cent over the medium term. Inflation is not great for economic stability because it erodes the value of people’s savings.
The risk of stoking inflation as growing demand meets limited supply is even more enhanced than it would normally be, he says, because there are other inflationary pressures in the system already.
‘‘If you are getting greater inflationary pressures coming through, then demand out of control is about twice as bad.’’
‘‘The rate was cut to encourage people to spend and businesses to borrow and invest on the basis that we were going to hell in a handbasket.’’
Gareth Kiernan
Infometrics chief forecaster
The OCR isn’t all there is
The official cash rate (OCR) is not the only driver of interest rates that banks pay. But as global economic conditions improve, the cost of overseas funding also increases.
The US Federal Reserve signalled overnight on Wednesday that it was likely increases in rates could be sooner than some expected and that had an immediate impact on the swap rates that help drive the cost of our longer-term lending.
These longer-term fixed rates have already started to shift up in recent months.