ASB picks OCR to go up sooner than expected, risk of inflation 'too high for comfort'

The official cash rate - at a record low since the pandemic hit - will likely start rising again before the end of the year, a major bank is predicting. 

ASB, previously picking the Reserve Bank (RBNZ) to move in May next year, now thinks the official cash rate (OCR) will start rising in November. The trigger was the Tuesday morning release of the NZ Institute of Economic Research's latest Quarterly Survey of Business Opinion, which reported the "most acute… scarcity of skilled and unskilled labour" in the survey's 45-year history. ASB called its findings "extraordinarily strong", showing "inflation risks getting too high for comfort".

When labour is scarce wages go up, driving inflation (as measured in the consumer price index, or CPI). Inflation is also being pushed upwards by supply chain disruptions thanks to COVID-19, and high demand in the construction sector, with consents at an all-time high. 

"The heady mix of strong household income growth, underpinned by stronger wage inflation, coupled with generalised and broad-based CPI price increases is a wage-inflation spiral waiting to happen," ASB wrote in its response to the survey. 

"Inflation expectations have started to creep higher and will likely continue to lift over the coming year."

A wage-inflation spiral happens when growing incomes push up demand for goods and services, whose prices rise accordingly, driving demand for higher wages, and so on. 

Labour is also scarce at present partly due to the closed borders. ASB says rather than rely on a steady stream of new potential recruits, firms are "now poaching staff off each other".

"Labour supply cannot easily grow to meet strong economic demand in the short term. As a result, we expect wage inflation to lift strongly over the coming year. Indicators clearly suggest the labour market is likely to return to the frothiness of 2005-2006," when inflation went up to 4 percent. 

The NZIER survey found a net 39 percent of firms increased prices in the three months to June 30, up from a net 7 percent in the first quarter of 2021 - ASB says this would correlate to inflation of about 3.4 percent. But one of the RBNZ's primary goals is to keep inflation between 1 and 3 percent. 

Keeping the OCR low has spurred borrowing and spending, and discouraged saving, but ASB says it's now " very clear that record amounts of monetary stimulus are no longer needed to support the economy".

"Against [the] backdrop of higher inflation expectations, the RBNZ is likely to become increasingly uncomfortable leaving the OCR at emergency settings. We now expect the RBNZ to start lifting the OCR from November this year."

When that change in the OCR trickles down to mortgage holders, it'll push repayments up. Just a 1 percent increase to 1.25 percent would cost the average borrower $4000 a year, Mark Riggall of Milford Asset Management told The AM Show last week. 

Other economists have suggested rising interest rates will be the only way to stop New Zealand's runaway house price inflation

The next OCR announcement is due in mid-July. The last time it went up was in 2014.