The Reserve Bank's decision on Wednesday on whether to lift the official cash rate (OCR) - and by how much - will have to take into account the "intense" economic pressures facing New Zealand, a leading economist says.
The central bank is widely tipped to hike the OCR at a meeting on Wednesday as high inflation bites at Kiwi consumers. Banks believe either a 25 basis point or 50 basis point rise is possible, but most seem to be leaning towards the former.
Brad Olsen, the principal economist at Infometrics, told AM ahead of the RBNZ decision that a 25 basis point jump is "the absolute minimum".
"Realistically, we know that we've got inflation running at a generational high. We've got the unemployment rate at a record low," he said.
"The pressures in the economy are intense and the longer we leave it without aggressive action, the harder it could become to unwind that level of inflation and the harder hit that New Zealand households would be."
Olsen said the central bank will have to "seriously toss up" a 50 basis point rise, something it hasn't done since May 2000.
While the RBNZ does sometimes make big moves pulling the OCR down - as it did during the Global Financial Crisis and at the start of the pandemic - it's cautious with big jumps upwards due to the effect on interest rates. The bank did mull over the idea of a 50 basis point jump at its last meeting in February, but went with the more conservative 25 basis points.
"We haven't seen such a big increase in quite a while, and so 50 basis points is certainly what we think needs to happen to try to get inflation under control," Olsen said.
"But the Reserve Bank is really trying to grapple with just how quickly it tries to get inflation under control at the same time as just how much they try to curb economic activity."
How does it affect you?
Olsen said it's likely mortgage rates will increase.
"Remembering that middle of last year, you could get a one year fixed mortgage rate for 2.2 per cent, you're now looking at 4.5 percent, if not more. We're picking that one year fixed mortgage rates will be above five per cent by the end of the year.
"All of that suggests that these increases to the OCR will see households paying more when it comes to mortgages, but that's also going to reduce just how much money they're spending in other areas, which is very uncomfortable but quite important when we know that the economy is currently spending above our means."
He said middle and lower income Kiwis are "feeling the pain quite hard in their pockets", so a jump in the OCR would be "bitter medicine to swallow, but in the long run will make us feel a lot better".
The RBNZ's remit requires it to keep inflation between 1 and 3 percent on average while also supporting maximum sustainable employment. The latest inflation data is out next week, but in January StatsNZ found inflation had jumped 5.9 percent in the year to December 2021, the largest jump since 1990.
"We know that fuel prices have massively increased since then," Olsen said. "We know that talking to a lot of store owners, a lot of households, a lot of businesses, prices have continued to go up."
"So now mind that inflationary pressure is even higher. We're picking a 7 percent inflation rate this quarter, so the Reserve Bank will want to be combating that."
ANZ is forecasting a 7.4 percent increase in quarter 2022, anticipating a continued uptick due to the war in Ukraine - which has had a major impact on global oil prices - the Omicron outbreak and the disruptions to supply chains due to the pandemic.
The March ANZ Business Outlook survey said inflation is "moon-bound", pointing to a "remarkable" net 96 percent of businesses who reported facing higher costs. All of those surveyed said that meant they intended to raise prices of goods and services.
Olsen said it's "great news" that unemployment is currently at a record-low 3.2 percent, but there are concerns that "wages aren't keeping up with inflation".
"Inflation, like I said, 5.9 per cent, wages up only 3.8 percent. What that means is that people are getting into work, yes, but they're also not getting nearly as much money.
"They're actually going backwards in real terms. The worry is that we're very much overcooking the economy. The Reserve Bank will be trying to limit that activity back."
With consumer confidence seriously down and the continued effects of Omicron, Olsen said the RBNZ will be thinking that "if they go too hard, they might kneecap the level of economic activity".
"In my mind, we're already starting to hit those capacity constraints in the New Zealand economy. If we don't get this inflation under control, it's going to be a very uncomfortable battle," he said.
"The Reserve Bank's going to have to make even greater increases over the next 12 to 18 months to get this inflation dragon back under control."
What's happening overseas?
It was revealed overnight that inflation in the United States rose 8.5 percent in the year to March, the largest annual increase since 1981. It was up 1.2 percent over the month, the biggest monthly gain since 2005.
Inflation has been soaring there recently off the back of the international supply chain issues, but US President Joe Biden on Wednesday put the blame squarely on Russia's Vladimir Putin.
"Your family budget, your ability to fill up your tank - none of it should hinge on whether a dictator declares war and commits genocide a half a world away."
Olsen said the US Federal Reserve is now looking at rising their equivalent to the OCR by 50 basis points.
"One of the central banks out of Europe increased 100 basis points in one meeting. That's one whole percentage point. So you are starting to get this feeling that after central banks, including New Zealand, have been caught on the hop, have been acting too slowly, they've really started to get going at the moment.
"They've started to make some very aggressive moves. I think that's where our Reserve Bank's going to have to head to, to get rid of this inflation, which again, really when it starts to bed in will last for quite a long time and we need to nip it in the bud."
