Inflation Remains Stubborn; Will Interest Rates Rise Further?

Tuesday, 25 January 2022, 4:09 pm
Article: Kalkine

The COVID-19 pandemic has seen supply chain constraints worsening globally, which in combination with rebounding demand, has fuelled inflationary pressures. However, the never-ending demand for goods has kept the businesses afloat, saving the economy from the prolonged recessionary scenario.

New Zealand is no different, where consumer prices have moved out of control in this recovery journey amidst robust demand and supply-side shortages. Meanwhile, property prices have been steadily rising in the country, aggravating inflationary concerns.

Consumer prices have continued to grow despite the central bank raising interest rates twice in 2021 to prevent price increases. Speculations are rife that the upcoming inflation numbers for the December quarter might be the maximum in about three decades. Market experts are forecasting annual inflation to reach over 6 per cent in the December 2021 quarter, the highest since the mid-1990s.

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Amidst these concerning expectations, the economy is looking forward to some policy action that might impact its speed of recovery from the pandemic-induced slump. This might mean another rate hike to cool down the red-hot inflation.

Food prices turning up the heat

Apart from a booming property sector, the country has also witnessed rapid price rises in the consumer goods segment. In 2021, food prices in NZ rose the most in 10 years, making the economic outlook for 2022 more uncertain. At the same time, the food price index, a measure of the price rise of consumption goods, jumped by 4.5% in December 2021 relative to the last year (Stats NZ).

This rise in food prices is especially significant as the segment alone makes up about a fifth of the overall consumer price index (CPI). To the uninitiated, CPI measures the change in prices of a basket of goods, depicting the overall price level in the economy. Additionally, the consumption of food items is a non-negotiable segment of demand as the food industry is booming all year round.

Given the soaring prices of food items, experts evaluate whether the existing policy action is adequate or further support is needed from the central bank. While some experts call for additional support from the Reserve Bank, a crucial point to note is that food prices have been increasing worldwide due to a common challenge – COVID-19.

Strained demand-supply dynamics have fostered a heated environment for food prices, fuelling fears of hyperinflation in some economies. However, it seems imperative for policymakers to examine whether the inflationary scenario is transitory or prolonged before taking any stringent decision.

What to expect from RBNZ?

The Reserve Bank of New Zealand’s (RBNZ) move to increase interest rates in October 2021 was touted as a timely decision for the economy. The central bank raised interest rates for the first time in about seven years to prevent inflationary pressures. Another rate hike followed the initial cash rate hike of 25 basis points to 0.5% in November.

Despite contractionary monetary policy measures, the central bank is yet to bring inflation under control. The RBNZ expects the official cash rate to increase to 2.5% by the second half of 2023 from its current level of 0.75%. Given the situation, experts suggest that a rate hike might not necessarily be the perfect solution for the existing price conundrum. This is because a mix of factors is driving the ongoing surge in prices.

Notably, supply-side bottlenecks have been a constant factor pushing up prices, which might which not resolve in the short run. Besides, consumers might be finding it more beneficial to save rather than spend in the high interest rate environment. This might put a brake on rebounding consumer demand, particularly in consumer discretionary goods.

At the same time, the Omicron variant looms as a major threat to consumer demand. Specifically, the uncertainty attached to the new strain can dent consumer and business confidence, potentially prompting an economic slowdown. In such a scenario, a rate hike might turn out to be more hurtful than beneficial in providing economic stability.

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Central banks across the globe are pondering over interest rate hikes to curb inflationary pressures prevailing across nations. However, for a country like NZ, which is a net debtor, multiple increases in the interest rate could be a challenge. Regardless of such concerns, certain experts foresee the central bank raising interest rates further in the coming months. It seems forecasters are hopeful that the CPI will simmer down to palatable levels soon.

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