What Rising Inflation Means For The New Zealand Economy?

Wednesday, 5 January 2022, 6:17 am
Press Release: Kalkine

Summary

• Inflationary pressures continue to remain high in New Zealand despite an interest rate hike by the RBNZ.
• Inflation may not always be detrimental to the economy as it stirs economic growth by generating higher revenues for domestic businesses.
• Further tightening of monetary policy could be expected from the RBNZ in the coming months.

Inflationary fears have steadily grown in New Zealand, alongside an improving economy and recovering businesses. According to Stats NZ, annual inflation hit 4.9 per cent during the September 2021 quarter, surging to its fastest pace in 10 years. The increasing inflationary pressures, along with the threat from the Omicron variant, are fuelling concerns around the near-term economic outlook of the country.

A rebound in the economic growth is often succeeded by rising inflationary pressures, as the economy sees rising consumer activity when it recovers, which bolsters the existing money flow. The central bank experts are of the opinion that the current increase in inflation is most likely temporary and could soon come to an end. However, other specialists seem to disagree as they fear that inflation levels bear semblance to the 1970s-like scenario when inflation reached a shocking 18%.

Warning signals heightened across the nation after the Reserve Bank of New Zealand (RBNZ) raised interest rates for the second time in a row to 75 basis points. However, much of the ongoing inflation was concentrated in the housing and construction sectors, which continued to face supply chain constraints and piling demand during the pandemic.

GOOD READ: Where do we see NZ interest rates going from here?

How long before inflation becomes undesirable?

New Zealand’s tryst with inflation seems to be a tricky one. While some amount of inflation is imperative to keep the economy going, current levels of inflation are feeding into increased inflationary pressures in the future. Essentially, this means that inflation could rise at a higher rate than its current pace of growth. More importantly, it could become increasingly difficult to keep inflation in check as it multiplies.

However, some argue that the fear surrounding inflation might be an overreaction as world economies have seen too little inflation over the past few years. Despite being a widely feared phenomenon, inflation has earned its status of being a necessary evil due to its inherent tendency to raise economic growth. Thus, experts have welcomed some level of inflation to boost the stagnant economy resulting from long lockdowns. However, the line distinguishing the desirable and undesirable levels of inflation seems blurred.

For the uninitiated, inflation is a massive increase in the prices of goods and services bought by consumers. If the value of payments increases on the consumer end, then the value of revenue earned by businesses also rises. However, the problem arises when the receiver of these payments is a foreign entity or an importer to the country or if there is a considerable increase in the cost of raw materials. A perfect example of such a case is the rise in fuel prices, which weighs heavily on the national economy. It will not be wrong to say that dissecting the root cause of inflation can hint at its gravity and longevity.

Could stagflation be a possibility?

Inflation that lasts for a long period, with low levels of GDP and employment, is known as stagflation. This is a commonly feared outcome of rising prices, which countries wish to steer clear of. Most stagflationary pressures in the past have occurred after a shock to the economy, which restricted economic growth and created massive supply-demand gaps.

Previous experiences of stagflation have acted as a cautionary tale, as governments across the globe, including the NZ government, have been extremely generous with their expansionary measures. However, market experts are hopeful that stagflation might not be a possibility in New Zealand due to a significant pumping of money into the economy by the RBNZ.

In this light, what can be expected is another round of tightening measures by the RBNZ in the coming year. As per RBNZ forecasts, interest rates could rise to 2.5 per cent by 2023 and even higher in 2024. Additionally, a rise in job postings could prompt quick labour market recovery and subsequent growth in the economic output while helping the businesses to stay afloat. On top of that, housing prices could rise further, which might need an additional check from the government.

All in all, the economy seems well-positioned to handle the persisting levels of inflation. Thus, one can expect decent economic growth for some time despite inflationary pressures, with labour market recovery bolstering the employment rate in the backdrop. Further tightening of monetary policy could occur over the coming months, which might take some steam off the housing sector. However, a drop in property prices seems a distant possibility.

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