How will inflation controls impact the housing market?

Recently lifting the Official Cash Rate (OCR) from historically-low levels to one percent in the first Monetary Policy Statement (MPS) of 2022, Reserve Bank (RBNZ) governor Adrian Orr has signalled more rate rises loom large on the horizon.

In response, banks have raised borrowing and deposit rates, while financial markets have fully priced in the expectation of a 3.25-percent OCR by 2024.

For Kiwis across the country, this not only increases the cost of everyday life but means the price of servicing debt has risen from record-low levels to something still shy of the double-digit interest rates experienced back in the 1990s.

COST OF LIVING

Inflation in New Zealand continues to rise steadily with the rising cost of everyday items including food, petrol and housing underpinned by high demand and low productivity amid ongoing disruption across supply chains and distribution networks.

Kiwi consumers are paying nearly five percent more for food, four percent more for rent and some 30 percent more for petrol when compared with a year prior.

Despite strong employment prospects and record-low unemployment, wages have failed to keep pace with the 5.9 percent inflation noted in the December 2021 quarter, meaning New Zealand’s households will be tightening their purse strings as they adjust to a higher cost of living.

While only a third of New Zealanders will be hit with higher mortgage lending rates, all Kiwis will feel the impact of the higher cost of living as the rising cost of non-discretionary items such as food and petrol leave less room for property deposits and elective residential investment.

MONETARY POLICY

With inflation accelerating and forecast to hit above seven percent by mid-year, the central bank is talking tough on controls to ensure it does not become an embedded feature of our economy.

Exacerbating pronounced inflation pressure by raising the OCR is intended to dampen consumer demand, however, economists say policymakers have a tough road ahead to ensure New Zealand’s monetary policy is not over-engineered to dip the economy into a recession.

During the uncertainty of the global pandemic, government expansionist and ultra-low interest rate policies worked well to keep the economy afloat – delivering a boom that saw residential property values exceed 30-percent value growth in the year to December 2021.

Following this unsustainable boost to residential assets, gently rising interest rates and interventionalist policy from both the government and the independent RBNZ have seen new lending data slow from extremely high levels recorded in the year to February 2021 – pointing to renewed hopes for more manageable affordability metrics.

GLOBAL DEVELOPMENTS

Despite much of New Zealand’s inflationary pressures beyond our domestic control – think oil prices, shipping costs and the shock of a global pandemic, geopolitical tensions and global developments continue to play an enormous role in the RBNZ’s monetary policy response.

As a worsening situation in Ukraine adds another element of uncertainty, employers are under increasing pressure to deliver wage growth that keeps up with the cost of living adjustments.

This has the potential to worsen inflation with upward wage growth feeding a perceived feeling of wealth; a phenomenon demonstrated during the pandemic as fiscal policy inflated asset prices and helped Kiwis to feel wealthier, supporting their spending and New Zealand’s economic health.

With policy-makers focused on the wider economic picture – preventing deep structural damage to our economy through inflation – property values may well become incidental as too much of a good thing means they have to put the genie back in the bottle.

However, household wealth across New Zealand, more so than any other country in the OECD, is inextricably tied to the national housing market, which may well give policymakers pause for thought before enacting dramatic policy that risks a recession as interest rates continue to move higher.