Inflation, interest rates and opportunities

25 January, 2011

Inflation’s a funny thing. It sort of creeps up on you unnoticed. So we thought we’d have a look at where it’s been since before the Global Financial Crisis hit in 2008, where people think it’s going from here, and how that’s going to affect interest rates and investment decisions for 2011.


The latest report from Statistics New Zealand showed the CPI rose 4% for the year to the December 2010. Obviously a major factor was the GST increase which showed up in the December quarter increase of 2.3%.


And no wonder our petrol tanks have grown, petrol prices increased 6.8% in the quarter due to the increase in the price of crude oil, higher excise duty, and of course GST. And I guess the egg burger cost more because for the year food prices rose 4.6% with milk egg and cheese prices up 12.6% to their highest recorded level.


Other notable rises included an annual rise of 17% in cigarettes and tobacco (well that was planned) and a 5.8% rise in the price of electricity. To see a good summary read the Sharechat article here
So let’s look at the trend over the last few years. The annual increase in the CPI for the years ended December in 2006, 2007, 2008 and 2009 were 2.6%, 3.2%, 3.4% and 2.0% respectively compared with 4% this time. For the CPI statistics go to Tables under Available Files at the Statistics NZ web site here.

Interest rates


It’s interesting to compare residential mortgage rates with the annual CPI increase. For example in September 2008 just before the Global Financial Crisis, the average bank residential floating rate was around 10% and the annual CPI increase 5.1%. By June 2009 the average bank residential floating rate was 6.4% and the annual CPI increase had dropped to 1.9%.


So how’s this latest spike going to affect interest rates? The Westpac economists view is the result is “in line with the RBNZ’s headline inflation forecast (where they estimated that ‘underlying’ inflation, excluding the direct effects of the GST hike and other government charges was 1.4%) it will have done nothing to sway the RBNZ from its plan to gradually increase interest rates from Q3 this year.”


BNZ economist Tony Alexander has a similar view. His key forecast is there will be a tightening through to mid 2012 with the next rate rise possible in June but he says this is highly conditional on the economy’s progress.


The global view


So much has changed in the last decade it is impossible to view the New Zealand economy in isolation to what is happening in the rest of the world.


A recent article in Time magazine entitled “A Changed Global Reality” sums it up well. Here are some of the points they make.


“Not quite 2 1⁄2 years ago, the world economy tipped into the most severe downturn since the Great Depression in the 1930s. World trade slowed sharply. Unemployment lines grew longer, especially in the old industrial economies. Financial institutions that had seemed as solid as granite disappeared as if they were no more substantial than a bunch of flowers in the hands of an old-style magician.”


“The new reality can be expressed like this. For more than 200 years, since the Industrial Revolution, the world has seen two economies. One has dominated technological innovation and trade and amassed great wealth. The second — much of it politically under the thumb of the first — has remained poor and technologically dependent. This divide remains stubbornly real. The rich world — the U.S., Canada, Western Europe, Australia, New Zealand, Japan and the four original Asian dragons — accounts for only 16% of total world population but nearly 70% of world output.


“But change is upon us. The developed world of the haves is struggling to restart growth and preserve welfare states, while the world of the once have-nots has surged out of the downturn. Big emerging economies like China and India have discovered new sources of domestic demand. Parts of Africa are attracting real interest from investors. All told, the strength of the developing world has supported the global economy. The World Bank estimates that economic growth in low- and middle-income countries contributed almost half of world growth (46%) in 2010.”


“In the long term, this is nothing but good news. As billions of poor people become more prosperous, they will be able to afford the comforts their counterparts in the rich world have long considered the normal appurtenances of life.”


They go on to say the world is in a much better state than many expected it would be a year ago. In the U.S. there are early signs that consumers are spending and banks are lending again, while the stock market is at its highest point in 21⁄2 years. Europe has so far avoided a collapse of the euro and a debt crisis spilling from small economies such as Greece and Ireland to much bigger ones like Italy and Spain.


Goldman Sachs economists have recently upgrading their 2011 global and U.S. growth forecasts to 4.8% and 3.4%, respectively. While 2010 was the “Year of Doubt,” 2011, they proclaim, will be the “Year of Recovery.” And U.S. economist Nouriel Roubini, the Cassandra of the crisis, reckons that if all goes right and nothing terrible goes wrong, the global economy might grow nearly 4% this year.


They do issue a word of caution though with the emerging economies facing risks of their own, the most alarming being a sharp rise in inflation — a result of strong domestic growth, stimulus policies, and commodity prices pumped up globally by returning demand, supply constraints and the loose-money policies of the West.


In early January, Fatih Birol, chief economist at the International Energy Agency, warned that oil prices, now over $90 a barrel, “are entering a dangerous zone” that could threaten the global recovery. The U.N.’s Food and Agriculture Organization said its food-price index reached an all-time high in December, surpassing the levels of 2008. Such spiking prices for the basics people need to survive are hard enough to swallow in the developed world.


“Just at the point you start to see a recovery coming, you get hit by commodity prices that hit people’s incomes,” says Stephen King, chief economist at HSBC. In emerging markets, the fallout can be much more severe. High food prices have already contributed to the collapse of the government in Tunisia. To read the Time article click here

So where is NZ going?


From all the information we can find the general opinion is so far – bearing mind most of New Zealand is just returning from holiday – the New Zealand economy is taking longer than expected to recover and any rise in the Official Cash Rate is unlikely before September. And if anything a rise can be expected later rather than earlier.


But whatever the timing there’s a definite feeling out there that 2011 is going to better than 2010 with consumer confidence up in the ANZ Roy Morgan Survey. In fact economic commentator Roger Kerr’s view is that all the economic data releases over the first 3 months of 2011 will prove to be better than expected. He says “there will be a realization that 3% growth does bring inflation risks later on and thus the super-loose monetary policy settings with the OCR at 3.00% are just not appropriate for the economic outlook.”


“By the time the RBNZ have the hard economic evidence they need to remove the monetary stimulus, it will already be too late and thus force them to lift official rates rapidly from March/April onwards. In addition to the RBNZ’s expected U-turn on the NZ economy, the improved global economy in 2011, led by the US and Asia, will also be aiding a stronger NZ economic growth outlook.” To see Roger’s article click here


Property guru Olly Newland, in an interview with’s Bernard Hickey last December, gave his view of the outlook for the property market after a difficult 2010. In this he said the bulk of the market stayed flat in 2010, contrary to forecasts of a 30% slump and he is now seeing some signs of confidence with rising average prices and volumes.


“People have looked back over the last 2 year and said to themselves: ‘The world hasn’t come to an end. The streets are still full of cars. The restaurants are still full of people. Business is still going on. Maybe this is all a bit overrated. Let’s get on with it’,” he said.


Newland said prices had got ahead of inflation between 2002 and 2007 and were now broadly flat, where it was still possible to make money. “That’s better than falling,” he said. He noted a similar pattern after a boom in the early 1970s.


He goes on to talk about investing in commercial retail property, the government’s GST increase and tax cuts that started from October 1, and investing in residential property. To view the interview click here

Tower Investments CEO Sam Stubbs, has a similar view on property (and other assets). Speaking at Tower’s inaugural quarterly briefing last week, he said inflation would be one of the dominant themes for the investment world in 2011. He said inflation was already beginning to rise around the world and this was being priced into the market.


In his view the developed world will have to keep printing money to fulfill promised stimulatory packages. And there were three main ways countries could dig themselves out of debt; by growing out of it, restructuring or inflation. “We think there will be a combination of restructuring and inflation.” he said


Despite predictions of interest rate rises he believed residential mortgage rates would remain relatively stable. He said banks remained committed to mortgage lending as their lowest risk form of lending. Accordingly owning or buying a house is a good idea.


“Most people buy a house by taking out a mortgage. Having a mortgage on a house with inflation around the corner is not a bad thing” he said.


To see the Herald report on the media briefing click here

It’s also interesting to read now Rodney Dickens’ Interesting Times of July 2007 “Inflation Causes Costs and Cures”. This was of course written in the boom times and of particularly relevance is the section “Higher inflation helps get housing affordability down after a speculative bubble.” To see that issue click here

So what does all this mean?


In our view:


  • The U.S. and European economies will take some time to get over the banking and financial crisis they have gone through – far greater than that experienced in Australia and New Zealand. This will mean interest rates will remain low as their governments attempt to stimulate the economy and reduce unemployment (amongst other things).
  • The Official Cash Rate here will not rise in the near future and when it does it is likely to remain at a lower average than it has in the past. (There is also some argument as to how effective raising the OCR is in raising interest rates here as 45% of bank funding comes from offshore – see my October GLOBAL VIEW here).
  • The recent 4% CPI increase here is an anomaly due to the GST increase but inflation is on the rise worldwide (being the easiest way governments can get out of the debt they have incurred to stimulate their economies).
  • Banks have to lend money because that’s their business. And their lending criteria will now be primarily debt serving ability.
  • Businesses have been hurting due to the lending practices banks have been taking – to some extent forced upon them by regulation – and by the demise of other lenders like the finance companies. There will be many opportunities for cashed up buyers – or those that have access to finance outside the potential target – to buy or invest in successful businesses that are carrying too much debt.
  • Commercial property will be judged by its ability to generate cash flow. Quality of tenants and terms of lease will be the key factor. There will be good buys for those who can attract tenants – whether it be by refurbishment, cleaver marketing, or the ability to postpone immediate rental cash flow. The beneficiaries will be those who are in the same cash position mentioned above.
  • Bare land may prove to be a long term hedge against inflation – but where is it and how long will you have to wait? Location where the land can be used is the key, not just scarcity (see what’s happened to the price of most coastal property over the last 2 years).

If you’re interested in discussing the any of the above, feel free to reply to this newsletter or call us any time.





From the team at Global Pacific.

Global Pacific Corporation Limited
P O Box 3229,

Shortland Street,

Auckland, New Zealand

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