Money Talks: When Will The Pain End? Interest Rates & Inflation.

Inflation, a reality affecting all of us to some degree irrespective of our race, gender, age, occupation, economic standing, political philosophies or religious observations. Yes inflation, the culprit of price increases, is alive and kicking after filing a leave of absence in Aotearoa for the past 3 decades. For some, raised in an era of cheap money, inflation is a new phenomenon to understand and contend with.

For others, the bad old days of spiralling price increases come sharply back to mind. Every one of us is subject to inflation’s tentacles in the form of increased expenses. Rent, mortgage repayments, food, transport, and petrol are but some of life’s essentials we’re paying much more for today than what we did a year ago thanks to the presence of inflation. How has this dire state of affairs transpired and when can we expect an abatement to our cost-of-living pain? Important questions given living is a popular pastime, now requiring all we earn and then some to sustain our existence.

CAUSE AND EFFECT

The first question is easily answered. Inflation has come about through central banks the world over reducing their internal rates of interest. Initially, this step was taken so ensure countries’ economies continue to function when the pandemic broke out. As time progressed, low rates were retained to help economies recover from the devastation COVID inflicted. Our own Reserve Bank engaged in this action, reducing the Official Cash Rate (OCR) to all-time lows to keep New Zealand’s economic engine from tanking when COVID visited our lands.

LOW INFLATION CONSEQUENCES

What has to be remembered is when the Reserve Bank cut the OCR, it did so off the back of an already low internal interest rate. As a general proposition, when OCR’s are low, so are bank lending rates. Like most cheapish things, low lending rates encourage the consumption of credit, made possible because more people are able to satisfy banks’ lending criteria. So, borrow they do for all sorts of things such as working capital for businesses, acquisition of shares and the darling asset class of Kiwis, property. This has certainly been the case for the past 10 years where low interest costs have seen high demand for these assets. Many companies whose shares weren’t that solid looked good care of cheap money coupled with a belief no other viable investment alternative existed which produced a reasonable return. Classic financial analysis of data was often replaced with promises of growth, leading to over valuations of many shares during the cheap money age. The same can be said for some property investments. Low lending costs made dog-eared properties look like great investments, producing never ending increasing capital gains and cash (rental income) returns. Ultimately, demand outweighed supply in both these asset classes, resulting in price trajectories.

Price wasn’t the only effect low borrowing costs brought about. Some people became economic winners seemingly overnight in the wealth stakes game. Unfortunately, others lost, through no fault of their own. A wealth divide between people was perpetuated. Those who owned a patch of dirt came out on the winning side of the ledger. Homeowners enjoyed large equity gains, accompanied by cheap on their pockets mortgage repayments. Landlords rejoiced too at amplified capital and cash flow returns care of inexpensive borrowings and rent rises. Those trying to enter the market however, often lived a different story. As property prices rose, finding affordable property to buy became a difficult task. The exercise was made harder by rising rents and trying to scrape together the continually increasing deposit required to step onto the rising realty ladder. People with cash didn’t fare any better as money held in savings and term deposit accounts earned negligible returns.

Anyone taking a hard look at New Zealand’s economic landscape at this time, could easily draw the dots. You didn’t need a degree in economics to forecast eco soundbites before they made news headlines. It was basic 101 economics after all, playing out right before our eyes. I literally pre-ticked off events, reading the Events Clock I’d crafted. It was obvious the party would need to come to an end … eventually. What no one entertained was how that ending would be written. Then again, black swan events are by their nature, unforeseen and unplanned for.

THE WORLD BUT NOT AS WE KNOW IT

Enter COVID, centre stage. A pandemic, affecting the world over, putting a spoke in the economic wheel. At the time I was overseas, happily ensconced on a rotating weekly basis in Melbourne and the Gold Coast. People in both cities were muttering about COVID but generally, Australians didn’t treat the virus as being that serious during the first few months of its lifetime.
Roll on a few weeks and things changed – abruptly. Chatter became louder. Rumours swirled. One morning, I was quietly told the Premier was going to close the border at 5pm that day. Sitting in a café trying to think through the situation, being accurately aware the clock was ticking and with it my run for freedom, I decided to leave. Victoria’s Premier might be shutting down Melbourne, but Annastacia Palaszczuk wasn’t having a bar of that. Queensland had no intention of entering a full lockdown. A frantic jamming of apartment contents into 7 suitcases ensued, followed by a dash to the airport. Bedlam greeted me. Everyone it seemed was trying to leave. By some miracle, I’d managed to get a mid-afternoon flight. I figured I’d be in Brisbane well before the 5pm curfew. I hadn’t counted sitting on a runway for over an hour, waiting for 9 other planes to take off before we could leave. Passengers on my bird were nervous and restless. Finally, we lined up for take-off. As my plane turned onto that beautiful straight asphalt pointing towards freedom, I counted 11 planes behind us. I hoped they’d make it into the sky before the curfew.
I felt I’d entered another world when arriving in Brisbane. Calmness prevailed and that is how it stayed for weeks as the world battled on. Slowly however the environment changed. One morning I walked the beach at Surfers Paradise – alone. I was literally the only soul on those golden sands. Tourists were no more. Cafes and shops had closed. Staff had gone home. The Gold Coast had emptied out. Friends urged me to return home, worried I’d be alone if I caught the dreaded virus. I brushed their fears aside because catching contagious bugs is a difficult exercise if there’s no humans around to infect you. Loneliness is another matter. You can catch that real easy without people to interact with. Fun was at an all-time low. The sun had disappeared, and a couple of work matters gave me the feeling it was time to wander home.

A stark contrast greeted me when returning to Auckland. New Zealanders were fighting, some literally for life. Economically things were dire. Freedom was severely curtailed. Job losses were mounting. Many goods, especially food items, were hard to get. Essential services were over-run. Everyone was worried, including the Reserve Bank. To counter the dire effects COVID was inflicting, the Bank reduced the OCR. Our main banks responded in kind, lowering lending rates, making serviceability criteria relatively easy to satisfy and loan repayments cheaper than a scoop of chips.

During these times, spending for many didn’t stop simply because they were ensconced at home. Keyboards got a pounding as we began in earnest internet shopping. Between and after lockdowns, armed with cheap credit, on-line shopping became a national sport. Demand for goods and services was unprecedented, driving prices upwards. Supplies were frequently exhausted.
When we finally came out of COVID, demand continued off the back of miniscule held inventories. Shopping malls became jammed. Retail was run off its feet and so was business. Labour became a scarce commodity. Wages increased as employers fought to attract and retain staff. Unemployment decreased. Near full employment meant more citizens had gold to spend and spend they did, causing more money to slosh around in the economy than previously. Ultimately, demand outweighed supply, resulting in upward price trajectories.

Unsurprisingly, we began shelling out more for the basic necessities of life like food, electricity and petrol. Month after month prices climbed and with it our expectations we’d pay more for goods in the future if we didn’t purchase today. Beliefs drive behaviours and that is exactly what drove us to continue to consume, adding petrol to the inflation fire quietly burning. It didn’t take long for our expectations to become a self-fulling prophecy. The word ‘Inflation’ started to be bandied about, with it putting down serious roots, rising from a low depth of 1.6% in 2019 (pre COVID) to dizzying heights of 7.3% in July 2022.