Market Update: The fight to inflation continues

February 24, 2023

As an investor, you’ve just left behind a tumultuous year. There really was nowhere to hide: against a backdrop of high inflation and interest rates being raised, almost all financial markets fell. It’s been a timely reminder that long-term investing is not about ‘hiding’ from risk, but ‘managing it’.

Inflation is likely to remain the key topic in 2023, as central banks continue to try and curb its effect. However, it looks like the narrative is starting to shift: most economists now seem to agree that we’re in for more interest rate increases, but maybe not to the same degree that we had in 2022. Read on for more on this.

RBNZ just lifted interest rates again

In a move that many economists had predicted, the Reserve Bank lifted the Official Cash Rate (OCR) again on 22 February, which will likely push up mortgage and term-deposit rates.

It’s just the latest chapter of the ‘central banks vs inflation’ saga, with more episodes likely to come through the year. This time, the RBNZ opted for a 0.5% increase, slightly lower than the 0.75% hike we saw in November. The 10th consecutive increase since late 2021 brings the cash rate to 4.75%.

Interestingly, while the RBNZ acknowledged that demand pressures are somewhat easing, both domestically and internationally, they also warned that there’s still work to be done to curb inflation. What’s more, as the Reserve Bank noted, the latest weather events across the North Island will likely have a heavy economic cost, alongside the already high human cost.

The exact implications are yet to be assessed, but the RBNZ expect prices for some goods to spike, activity to be weaker than anticipated, and export revenues to be negatively impacted.

Bringing inflation down is not an easy fix

Despite the fastest-ever interest rate increases New Zealand has ever seen, the current inflation has proven to be a lot more ‘sticky’ than expected. According to the latest Consumer Price Index (CPI), the inflation rate didn’t drop an inch in the past two quarters, persisting stubbornly at 7.2%. Slightly lower than what our Reserve Bank expected (7.5%), but still not quite low enough.

Of course, no one – and certainly not central banks – expect inflation to just disappear overnight.

The RBNZ once again confirmed what they had already said in November: further monetary tightening (with more interest rate hikes) is needed to meet the inflation and employment goals, even if that means pushing New Zealand into a recession.

Following the OCR announcement, Kiwibank economists said that the risk of overtightening is growing: it’s clear that the RBNZ seems want to go full steam ahead, with no backward steps. The challenge, as we’ve seen, is that increasing rates is not a silver bullet.

What are the hurdles?

Part of the inflation is ‘imported’ and affected by factors outside of New Zealand’s control (like the price of oil). But there are domestic factors weighing in as well, including a couple of major ones:

  • High demand (consumer spending) and low supply, which is essentially what the RBNZ is trying to dampen with interest rate hikes;
  • Our extremely tight labour market, exacerbated by the two-year border closures that have only recently started to loosen up.

Looking at the latter, New Zealand’s unemployment rate has remained at or near historic lows since the September 2021 quarter. The latest Stats NZ figures saw only a slight increase, from 3.3% in September 2022 to 3.4% in December 2022. There are signs that migrant workers are returning, but it’s not yet clear how quickly labour shortages will dissipate. In addition, New Zealand is competing with the rest of the world for labour and while the lifestyle may be good here, in many cases the wages are not.

As a result, the economy is experiencing a price/wage spiral, further fuelling inflation. Wage increases lead to higher business costs. Higher business costs lead to price increases, underpinned by high demand and low supply. And with the cost of living rising, the tight labour market gives employees and unions wriggle room to negotiate higher wages.

This is the vicious circle that the Reserve Bank is trying to break by rising interest rates.

What are the risks?

If demand (consumer spending) reduces, then price growth eventually slow down. Unfortunately, it’s likely that some jobs will be lost in the process, higher mortgage rates will put the squeeze on homeowners’ budgets, and there is a chance we will enter a recession.

On the other hand, letting inflation run its course for an extended period of time is still quite dangerous for the economy. And even if we need a recession to tame inflation, many economists agree that it might not be a severe one.

As always, it’s important to put things into context. We might meet the technical definition of a recession, but for a long time the economy has been booming. Despite a pandemic, markets have shown resilience. Arguably, the time was ripe for a ‘reset’, though it won’t be painless.

What does it mean for investors?

As we said, 2022 was a difficult year for investors globally – but you’ve ridden through it. And while there’s still a lot of uncertainty, markets seem to be comfortable with where things are at the moment.

For the month of January, the New Zealand share market was up 4.3% and global markets represented by the MSCI Country World Index (NZD) are up closer to 5.4%. If you had taken your money out of your portfolio and put it in the bank, you wouldn’t have made that return in the same timeframe.

Remember: the market is unpredictable and everyone, including economists, can only make educated forecasts. When the market bottoms and turns – as it has always done in the past – it will happen quickly and unexpectedly. Missing the initial recovery can have a big impact on your investment portfolio. As we have alluded to many times, trying to time the market by jumping out and then getting back in when things improve, is a game of luck. Successful investing is not about luck, it’s about ‘sticking to the plan’.

Remember, the market is now substantially cheaper than it was 12 months ago. So instead, talk to us about whether increasing your KiwiSaver contributions and/or drip feeding any lump sums you may have into the market is right for your situation and objectives. As Warren Buffet once said: Be fearful when others are greedy and greedy when others are fearful.

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Do you have any questions for us? Please don’t hesitate to contact us. We’re in your corner.

The information contained in this publication is intended for general guidance and information only. It has not been personally prepared for you. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult with us before making any investment decision. Historical market performance may not be indicative of future market performance.