We have heard an awful lot about inflation in the last few months.

But what exactly is it and why is it having such a big impact on mortgage rates?

We’ll explore that questions and what’s been happening in the world of finances now…

What Is Inflation?

We’ve all heard the word inflation before, and know that it can have a big impact on the general economy. But, what is inflation actually?

Well, inflation refers to the general increase in the prices of goods and services within an economy over a period of time. When inflation rises, each unit of currency buys fewer goods and services than it did before. In other words, the purchasing power of money decreases.

Inflation is typically measured as an annual percentage rate, calculated by considering the percentage increase in the average price of certain goods and services over a specific time period. The Reserve Bank closely monitors inflation because it significantly impacts the economy.

Sustained high inflation can put the country’s currency and financial system at risk. This is why The Reserve Bank and policymakers aim to maintain stable and moderate levels of inflation to support a healthy economy.

How Does Inflation Impact The OCR?

As we’ve already learned in previous months, the OCR has a flow on effect when it comes to setting mortgage rates. You can read more about that here. But, if we take a step back from that, inflation is one of the factors that the Reserve Bank consider when setting the OCR.

Here’s how it can have an impact:

Targeting

The Reserve Bank operates under an inflation targeting framework. This means they set a specific target range for the inflation rate and adjusts their monetary policy tools, including the OCR, to achieve that target. In New Zealand, the target range for inflation is typically around 1-3%.

Rising OCR

If the Reserve Bank observes that inflation is rising and is projected to exceed the target range, it might respond by raising the OCR. By increasing the OCR, the RBNZ makes borrowing more expensive for commercial banks, which can lead to higher lending rates for consumers and businesses.

In theory, this will reduce spending and borrowing in the economy, helping to slow down demand and moderate inflationary pressures.

Falling OCR

On the other hand, if inflation is below the target range or if there are other economic factors causing a slowdown, the Reserve Bank might lower the OCR. Lowering it makes borrowing cheaper, encouraging consumers and businesses to spend and invest more. This increased economic activity can help boost demand and bring inflation closer to the target range.

Expectation

Decisions regarding the OCR also depend on inflation expectations. If people and businesses expect inflation to increase, they might adjust their behaviour, such as raising prices or negotiating higher wages. These actions can contribute to higher inflation. The RBNZ takes these expectations into account when setting the OCR.

Economic Conditions

In addition to inflation, the OCR also takes into consideration other economic conditions, such as employment levels, economic growth, and global economic factors. These conditions can influence the Reserve Bank’s decisions about whether to raise, lower, or maintain the OCR.

Inflation + OCR

Overall, the relationship between inflation and the official cash rate is based on the Reserve Bank’s goal of maintaining price stability and ensuring that inflation remains within the target range. The OCR is a key tool used to achieve this objective by influencing borrowing costs, spending, and investment in the economy.

As we know, the OCR is a big driving factor in determining mortgage rates. So, that is how inflation is having a big impact on the current interest rates.

What’s Been Happening?

Inflation Watch

Now that we know a bit more about inflation and how it can impact our economy, have the Reserve Bank’s actions had the desired effect so far?

Unfortunately, inflation still remains stubbornly high at 6% and Westpac economists expect it to remain elevated over the coming year. That will mean continued pressure on household budgets. The Reserve Bank had paused its monetary tightening policy, but a final OCR rise could potentially be on the cards later in the year.

For all of us trying to buy groceries and pay our mortgages, this isn’t necessarily good news. But, only time will tell when it comes to mortgage rates. With uncertainty in the market, it is always advised to speak with an expert mortgage adviser before making any decisions regarding your mortgage.

Housing Market

Experts predict we may be nearing the bottom of the housing market with the rate of decline dropping for the fourth month straight.

“The QV House Price Index for July shows the average home dropped in value by 1.5% nationally over the July quarter, which is a smaller rate of decline than the 1.8% in June, and considerably lower than the 3.5% and 3.4% quarterly declines in April and May respectively. The national average now sits at $888,999. That figure is now 10.2% less than the same time last year, but just 0.3% lower than at the end of June” [source].

What does that mean? Well, house prices may start to even out soon. So, it is wise to take expert advice before making any moves in the property market.

OCR Forecast

Economists are forecasting that the OCR will remain high into 2025, potentially sitting around the 4% mark. This is due in large part to increased immigration numbers after Covid.

It’s predicted that the economy will “flirt with negative growth between now and 2024… Gareth Kiernan, Infometrics chief forecaster, says be it a continued slowdown, a double-dip recession, or any other description, the economy is still going to look and feel weaker throughout the rest of this year and into the next.

That’s the price we’re paying to get inflation under control and put the New Zealand economy on a more sustainable path.” At least he says, the country is now seeing the effects of the tightening in monetary conditions coming through.”

While this does not promise short term relief from mortgage rates, we are starting to see signs that the OCR hikes are having the desired effect. So, it will be about weathering the storm in the coming year, and we can help you do that here at Mortgage Suite with expert financial advice.

Contact our team today with any questions you have about your mortgage or current rates.