Interest Rate Cycle Under Labour Headed For 6 Percent
In 2004, then Labour Finance Minister [Sir] Michael Cullen, was in a difficult position to work with the Reserve Bank Governor Alan Bollard and effectively address the significant inflation. At that time, the Reserve Bank was preparing for its fifth interest rate hike in a row, pushing the OCR to the remarkable level of 6.25%.
The reasoning, driven by stronger than expected inflationary pressures, was that the inflation figures were looking to exceed the Reserve Bank 3% threshold. This inflationary pressure was likely to stay for at least 2 more years, pushing until 2006.
The result of this intensive focus on inflation resulted in a monetary policy that brought the Floating mortgage rates close to 9%.
What it also did was place New Zealand in a unique position where housing and the industries and jobs around housing were becoming stagnant.
The New Zealand economy faces very similar circumstances today. Moreover, the explanation for how this impact would not decay the overall economy was the same in 2004 as it is today. There is an assumption that hikes in the interest rates would impact household spending since there was a strong number of existing fixed term mortgages.
However, the result of this policy of raising rates so intensively to manage inflation was a complete and artificial cap on residential development, decaying the related job markets and related industries by 2006.
Within 24 months of these substantive interest rate hikes, performed to reduce inflation, the economic pendulum swing caused an abrupt end to housing activity.
The actual events and reactions in 2004 are uniquely similar to the current conditions, where oil prices are expected to rise, inflationary pressures are front-and-centre to politics and policy, and there was a strong labour market.
By 2007, New Zealand saw a marked drop in housing development across all regions, while also seeing a gradual decay in the labour market and decline in growth. The interest rate hikes had caused a more rapid cooling of the economy than originally anticipated. The unique situation, with Bank rates toying in the 9% range was ironically degrading the housing market and all associated industries, while the world was slowly moving towards the 2008 crash.
It was this GFC that actually allowed the extreme high interest rates that were set 4 years earlier, to provide an economic buffer and offer the Reserve Bank a reasonable tool to address the global crisis. At that point, interest rate cuts became the norm resulting in a return to the same cycle.
The methodology for addressing economic pressures does not appear to have necessarily changed, albeit banks and the industry have been far more resilient in recent years due to substantive improvements in policy and practices stemming from changes in BASEL reforms and Central Bank requirements.
However, the systemic economic boom bust cycles remain integral to the policy practices and unfortunately also provide a type of looking glass into future events.
A more affable methodology, where reactionary measures are tempered, may provide smoother transitions in this derived economic cycle.
Trend Analysis Network is a think tank based in New Zealand created to identify and publish analytical results of future trends in politics, society, and economics.
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