Reserve Bank may be forced to 'keep hiking until something breaks'

Friday, 28 January 2022

The consumer price index (CPI) records changes in the price of hundreds of goods and services. (First published January 20, 2022)

The coming year is likely to be a tough one for investors, forecasters warn, with weakness predicted across most assets.

Investors have already had a rough start to the year – the NZX50 is down more than 7 per cent over the last month and bitcoin is off by about 25 per cent.

Data shows house price growth slowing with predictions of small falls later this year.

Inflation, which has reached levels not seen in more than three decades, is quickly changing the picture for investors who have become used to an environment of low interest rates and stimulus.

Sharon Zollner says it could be hard for the Reserve Bank to engineer a soft landing.

* How high will interest rates go in 2022?

Reserve Bank governor Adrian Orr voiced concern in August about the situation recent home buyers might soon be in, and since then prices have risen rather than fallen. (Video first published August 19, 2021)

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“The whole investing environment has flipped from ‘central banks are going to be printing money and keeping rates low forever’ to ‘central banks have a big job to do on inflation and they’re going to have to grit their teeth and keep going even if asset prices get a decent wobble’,” said ANZ chief economist Sharon Zollner.

She said central banks might not think a bad run for investors was necessarily bad news. They might think a slowdown in house price inflation and equities was helpful because it would dampen consumption.

“Even though we’re not forecasting consumption to be very strong anyway … that’s the thing about negative supply shocks. They mean your economy cannot grow as fast. If your potential growth rate is lower and you’re trying to reduce inflation you need actual growth to be even lower still. It’s not a pretty picture for company earnings and therefore equities and also for investment decisions.”

She said, if interest rates were going up, “the maths can change quite quickly for the likes of equities and the housing market”.

Central banks around the world were shifting to increase rates. In New Zealand, the Reserve Bank has clearly signalled it is on a path of increases.

“In the middle of last year the Reserve Bank was really out on a limb being the only ones talking about the need for higher interest rates, now everyone is on the same page… It’s a more volatile environment than investors have become used to.”

Increased shipping and labour costs are adding to price pressure.

Zollner said volatility had been abnormally low recently because of the “morphine” that central banks had been dosing the world with.

The process of easing off that stimulus could be unpleasant. “We could experience some withdrawal symptoms. The mood is changing. People thought inflation was temporary now they’re realising it’s looking really long-lived.”

She said there was a risk that central banks had painted themselves into a corner and had to keep hiking interest rates “until something breaks”.

“We could end up with a hard landing. Historically when central banks have realised they’ve got a massive inflation problem to address it ends in a hard landing.”

Zollner said, while ANZ now expected the OCR would need to increase to 3 per cent, a higher end point than its previous prediction of a peak of 2 per cent, there was a risk of something going “pear-shaped” before the rate reached even 2 per cent.

“The forecast is signalling how big a job the Reserve Bank is facing. It’s become clearly a bigger job. Engineering a soft landing from this starting point will not be easy.”

Gareth Kiernan, chief forecaster at Infometrics, said there was not a lot of good news for investment assets.

“I suspect that expectations for cash rates will need to rise further and longer-term bond rates will be driven higher as well. Those shifts are likely to put further downward pressure on share prices, which had been premised on lower interest rates sticking around for longer. House prices within New Zealand will also feel the squeeze, although I’d argue at the moment that the [new lending rules via the] CCCFA has been more instrumental in slowing the market to date.”

He said investors’ risk aversion would be fuelled by the Russia-Ukraine situation and concerns about the robustness of China’s economic growth.

“Furthermore, the emergence of Omicron has raised uncertainty about the possible endpoint of the pandemic… Whatever the case, 2022 is shaping up as another uncertain year – much like 2021 disappointed with the failure to return towards normality globally – and if there’s one thing investors don’t like, it’s uncertainty.”

At ASB, senior economist Chris Tennent-Brown said while rising interest rates might sound like a positive thing for people with money in the bank, there was no good news there, either.

“Interest rates have been rising and they’re going to keep rising because of inflation but they’re not keeping pace. You can get a 3 per cent term deposit now but only if you lock your money away for five years. That might be fine if inflation was back at 1 per cent but when it’s close to 6 per cent and people are talking about it hanging around 2 per cent or 3 per cent over the next year, you’re no better off for the nominal increase.”