It’s common knowledge that inflation has been too high for too long in NZ.

And we’ve heard all the experts telling us that it’s a really bad thing.

But, why is that?

How does inflation have a vice-like grip on our economy right now and why has it not gone down despite interest rates sky rocketing and households feeling the pinch?

Well, let’s look at that question now and explore how tricky the job of reducing inflation seems to be.

Why Is It Bad To Have High Inflation?

In New Zealand, the target inflation rate is between 1 – 3%. As of October 2023, the current inflation rate is sitting around 6%. Clearly, we are quite far away from the target window.

So, why is it such a bad thing for inflation to be high?

Well, there are a number of reasons why we can see the Reserve Bank working so hard to bring the rate down. These are a few of the main ones:

Reduced purchasing power

High inflation takes away some of the purchasing power of our dollar. If prices continue to rise month on month, like we’ve seen recently, people find it increasingly difficult to afford the same amount of goods. Effectively, the money you earn will buy less than what it did before. This can reduce your standard of living and quality of life.

Economic uncertainty

It’s not only individuals that are impacted, businesses also feel the pinch because high inflation leads to economic uncertainty. Consumers have less money to spend, so they delay making purchases other than essential items.

It is hard for businesses to operate under these conditions as they need people to buy their products in order to keep the doors open! When businesses have fewer people spending with them, they can’t plan for the future as they don’t know when the funds will roll in again. This results in economic instability for the whole country.

Higher interest rates

High interest rates are at the front of every mortgage holder’s mind. When inflation is high, the Reserve Bank tries to combat that by raising the OCR. As we’ve learned in the past, the OCR is one of the main considerations for setting mortgage rates. When the OCR goes up, so do interest rates.

Higher interest rates can deter borrowing and spending as everyone is focused on having enough money available to keep a roof over their heads. This lack of money circulation negatively impacts the country’s economic growth and makes businesses hesitant to hire more people.

Basically, there is less money circulating through communities as everyone is prioritising servicing their mortgage. Around these times, you might see your favourite small businesses closing as it is no longer financially viable to stay open with people spending less.

Why Is It Taking So Long For Inflation To Come Down?

Now we know why high inflation is a bad thing and why the government and the Reserve Bank are working hard on reducing inflation. But, why is it taking so long?

Reducing inflation at any speed relies on:

• Economic conditions: Inflation reflects supply and demand dynamics. If demand is high and supply is low, it can take longer for inflation to come down. We are seeing this in the marketplace as consumer spending is still high, partly as a result of migration increasing in the aftermath of Covid restrictions lifting.
• Monetary policy: As we know, the Reserve Bank are doing their part to reduce inflation by raising the OCR. However, it takes time for those changes to have an impact. Because many NZ mortgages are on fixed term rates, the pain of increased mortgage rates can only be felt when those fixed terms expire and a new interest rate must be fixed.
• Expectations: Inflation expectations can impact the rate at which inflation reduces. If people expect inflation to persist, they may request higher wages. When businesses pay more wages, the cost of goods has to remain high to cover these costs. Suddenly, you have created a self-fufilling cycle of inflation. Only when the expectations change can inflation be reduced.

How Long Will This Current Situation Last?

Economists are confident that the high inflation war can be won. But, it’s not something that will happen overnight. As we know, the OCR remains at 5.5% after the Monetary Policy Committee chose not to increase it on 4th October. This is because interest rates seem to be constraining economic activity and are starting to reduce inflationary pressure as required [source].

However, we aren’t out of the woods just yet. “Kiwibank says the RBNZ’s plan is simple: lift interest rates to a point where they hurt, and hurt a lot, and then wait for inflation to be stifled and restrained to something more stable, like 2%.” [source].

With inflation currently around 6% we have a long way to go. “To tame the prickly inflation beast, monetary policy needs to be left at restrictive levels, for longer. The RBNZ notes ‘a prolonged period of subdued activity is required to reduce inflationary pressure,’ says Jarrod Kerr, Kiwibank economist [source].

The good news is that the probability of further OCR hikes has reduced. It might be that the Reserve Bank has done enough to date to turn the tables on inflation. If all goes according to plan, inflation will reduce in the coming months and they can look to move the OCR down with more favourable borrowing conditions appearing in late 2024 or 2025.

However, this will depend on whether a further OCR hike happens in the upcoming 29 November 2023 review. So, at this stage, we will await that announcement before making further predictions.

Our Advice

In this uncertain market, it is still our recommendation to seek advice from an experienced mortgage broker before making any decisions about your current mortgage or any potential borrowing.

Here at Mortgage Suite, we specialise in giving personalised financial advice tailored to your individual situation and the current circumstances in the mortgage market. We’d love to have the opportunity to discuss your mortgage needs as we might be able to create a better structure for your current situation.

Chat with our team to find out if that’s the case now.