By Peter Nicholl
This month, I return to my pet subject, interest rates and inflation – I was after all, a Central Banker for nearly 40 years. The issue is topical again because on October 6 the Reserve Bank of New Zealand (RBNZ) increased their Official Cash Rate (OCR) for the first time in seven years.
The increase was a very cautious one of 0.25% and took the OCR to the still incredibly low level of 0.5%. A number of banks immediately increased their mortgage and deposit interest rates. Without being explicit, the RBNZ indicated that this modest increase was likely to be followed by further increases. The market consensus seems to be that the OCR could reach around 2.5% in 18 months. While that is a big increase from today’s level, it is still historically a very low level.
The next bit of information the RBNZ and the financial markets have been waiting for was the CPI increase for the September quarter. It came out on Monday. My prediction was an increase of over 2% – I told the editor that on Saturday. It doesn’t cause me joy to say I was right. The CPI increase in the September quarter was 2.2%. Excluding quarters where the CPI figure was pushed up by increases in GST rates, this was the highest quarterly CPI number New Zealand has seen since the June quarter 1987. Price increases were widespread with prices for 10 of the 11 groups the Statistics Agency divides the data into rising.
CPI inflation for the year to September was 4.9%. Inflation in NZ is now running well above the RBNZ’s medium-term target of 2%. The same thing is happening elsewhere. For example, current CPI inflation in the USA is over 5% and they too have a target of around 2%. The RBNZ has at least taken a first small step to take their foot off the monetary accelerator. The US Federal Reserve has said they might start doing that next month.
Why are so many Western Central Banks acting in such a relaxed manner to the recent surge in inflation? It is because they believe the upward pressure has come mainly from disruptions linked to the Covid outbreak and should therefore be temporary. They expect (hope!) inflation will fall back to their target ranges once things return to normal. I think the Central Banks are being too complacent and there is a risk that inflation could become entrenched unless they act more quickly to reign in the current surge in prices.
I fear that there could be another reason why the Central Banks are being unusually reluctant to raise interest rates to ward off inflationary pressures.
They have dug themselves into a hole where their twin mandates of price stability and financial stability could soon be in conflict. They will be under pressure to raise interest rates more quickly and further to contain inflation.
But by doing so, they will generate non-performing loans and the start of the next financial crisis.
This dilemma Central Banks face runs the risk of generating stagflation. That would be the worst of all outcomes. Stagflation is when a country is facing price increases and low or no growth simultaneously.
I will tell you what I think about that issue in my next column.