Today’s inflation forecast: Subdued, with a chance of increased credit control

What are the chances that interest rates will rise sharply, cause big cash flow problems for home owners, and produce a 10% plus decline in Auckland house prices? Very slim. Why? Because the key driver of rising interest rates is rising inflation and central bank efforts to fight it, and all around the world apart from Venezuela inflation is low and showing little sign of rising.

Here in New Zealand the Reserve Bank has got its inflation forecasts wrong (too high) for almost five years – but they are in good company because practically all of us forecasters have incorrectly predicted inflation. The current inflation rate for instance is only 0.4% yet two years ago the Reserve Bank expected the rate to be 2.1%, and the forecast one year ago was 1.3%.

Why the errors? Since the global financial crisis the relationship between things has changed. In some countries low inflation mainly reflects low growth. But our economy has grown 2.5% in the past year so that is not the cause here. Lower oil prices have definitely played a part, but not enough to explain the difference between a 2.1% inflation forecast and an outcome of 0.4%.

In some countries jobs growth has been slow therefore wage pressures mild. But here in New Zealand employment has grown by a strong 260,000 since 2009. Yet wages growth has not lifted with such jobs growth as used to happen pre-GFC. Why? Perhaps it is because employees are less willing to ask for wage rises when they see so many reports of worrying conditions overseas. No-one wants to risk being last-on and first-off at a new firm they might be forced to move to if the boss refuses to give the wage rise asked for.

But there is more in play than that. Some inflation restraint is coming from disruptive technologies affecting service delivery methods. Uber for instance in the taxi market, Netflix for television. But the services affected tend not to account for a lot of consumer spending so this is not the answer. A better answer may simply be that consumers can now more easily push back against price rises initiated by retailers.

Before the smartphone appeared the cost to you and I of searching for an alternative supplier of a product which we had just discovered as costing more than we expected was very high. We might have to drive around town to different shops thus bringing a cost of time and petrol. Nowadays however, when confronted with something costing too much we simply look for an alternative supplier online and perhaps point out to the retailer standing in front of us that there is a model $20 cheaper available with free delivery from a supplier across town, elsewhere in NZ, or even offshore.

The cost to you and I of searching for alternatives has plummeted and that means retailers have difficulty recouping higher costs or simply trying to boost margins. This is not something which seems likely to change in the future and partly for that reason the chances seem high that global inflation will remain low going forward.

On the face of it this is good for the housing market because sustained low inflation means sustained low interest rates. But how then does our central bank contain risks it sees building in the housing market? Without being able to raise rates they must resort to direct credit controls. So far we have a 30% deposit requirement for investors buying in Auckland, and limits on bank lending at less than 20% deposit all around the country. Yet prices are soaring anew in Auckland and have started rising rapidly elsewhere except in Christchurch.

Hence we have talk of a new credit control in the form of debt to income limits. It is possible that within a year borrowers will not be able to borrow more than 5 times their household income. What will the impact be? Hard to say but note this. In Ireland banks cannot lend more than 3.5 times income. Average Irish house prices rose 7.4% in the year ending March. In Dublin the rise was 10.5%. UK prices have risen 5-10% the past year with lending limited to 4.5 times income for 85% of borrowers. The chances of new controls radically affecting Auckland house prices appear very, very low.

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