Interest rate rises, and the risk of a 'hard landing' for the economy

Tuesday, 12 April 2022

Reserve Bank governor Adrian Orr discusses the level of concern about inflation in February.

Dileepa Fonseka is a Stuff writer on business and politics.

OPINION: One story will always stand out to me from the early 1990s: a person who told me he lined up for a job at a petrol station and found out he was one of 100 applicants.

He didn’t get the job.

It can be hard for younger generations to imagine that stories like these, of a time when unemployment was biting and interest rates high, could happen in the present day.

Meanwhile, older generations might struggle to believe New Zealand could be about to enter such a period again.

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But the geopolitical challenges are piling up: the war in Ukraine and lockdowns in China are just two. Then there is Sri Lanka, which is running out of foreign reserves, and where Fonterra – which has a dominant position in the market there – is providing goods on extended credit.

You can add turmoil in countries like Sri Lanka to a list of geopolitical woes around the globe.

Global instability leaves New Zealand at risk of making a “hard landing” with each turn of the official cash rate-hiking wheel.

Another turn is due to be made on Wednesday afternoon, with a hike of either 25 or 50 basis points likely.

Sharon Zollner says hiking interest rates now could prevent the need for much steeper hikes in future.

Announcements from the Reserve Bank land with much more of a thud in New Zealand than they do overseas.

Central bankers in many other countries make speeches and speak more openly with the media between announcements.

This gives them a chance to shape their ideas before any official changes are made, and it is also a good way of setting expectations so that the announcement itself doesn’t come as so much of a shock.

In New Zealand, we normally get radio silence until the big reveal on the day.

With inflation running hot, the Reserve Bank has to balance its desire to temper inflation with a need not to take the economy out at the knees. Where central bank policy can go wrong is when it tapers the economy off too sharply, causing a lot of pain and economic misery in the process.

Higher interest rates bring demand down, and lead to firms hiring fewer workers, or paying them less.

Reserve Bank governor Adrian Orr used to say the “path of least regrets” was to not clamp down on inflation too quickly, lest there be wider consequences for unemployment.

Craig Renney says any “hard landing” will likely come about from an external geopolitical shock.

But at the University of Waikato’s economics forum in February, he signalled he was now more worried about inflation than unemployment.

“Our path of least regrets has now become one where we must ensure that consumer price inflation, and inflation expectations, do not rise persistently above our target level,” Orr said.

ANZ chief economist Sharon Zollner agrees the risk of a “hard landing” for the economy grows with each rate hike, but she also sees dramatic interest rate rises now as a way of stopping hard landings by preventing the need for even more aggressive increases in the future.

She notes unemployment is at record lows, meaning that, even if a downturn takes place, it might not filter through to significantly higher unemployment any time soon.

David McLeish says some investors are moving out of low-risk investments into cash, even though inflation is eroding its value.

She argues that, if you can tame inflation now, it means you never end up in a situation such as the country faced in the early 1990s, where interest rates were kept high in order to ward off inflation.

“It certainly smashed inflation, but it did an awful lot of other damage as well.”

Back then, New Zealand was still suffering the after-effects of the 1987 stockmarket crash, it was facing a major credit rating downgrade, interest rates were high, but inflation was also running at a pace that would remain unsurpassed for three decades.

Then, to make things worse, Saddam Hussein invaded Kuwait, causing oil prices to rise by nearly a third in three months towards the end of 1990.

Council of Trade Unions economist Craig Renney argues high inflation and high interest rates combined with a major geopolitical shock could cause a similarly hard landing now.

“If that occurs, then traditionally you’d be looking at significantly elevated rates of unemployment, and it would be hard because it would probably involve permanent wealth destruction.

“You’d be looking at house prices falling significantly as interest rates are ramped up to deal with elevated inflation.”

Are people nervous? Fisher Funds head of fixed interest David McLeish can see one big sign that they are.

His firm has 270,000 clients and right now they are seeing a trend of customers moving out of conservative investments such as bonds and just keeping that money on hand as cash, even though the value of cash is being eroded by high inflation.

“In most cases they’re becoming more concerned, they’re becoming more conservative, and that’s largely because of all the worries that are out there in the global economy right now.”

Spook people too much, and things could get more painful than they need to be.