Stagflation showdown: experts spar over early rate hikes as oil shock jolts NZ economy
The gist
Experts are clashing over whether the Reserve Bank should hike rates now to fight surging oil-fueled inflation—or risk tipping New Zealand into a full-blown stagflation spiral.
What to know
- Advocates like Mark Lister urge a preemptive OCR jump from 2.25% to 3% to anchor inflation expectations as fuel prices spike.
- Skeptics warn that raising rates during a supply-driven shock and economic stagnation could deepen New Zealand’s slowdown, not solve it.
- With inflation expectations above 3.4% and a stubborn 5% GDP deficit, the Reserve Bank faces a no-win balancing act that could impact NZ’s AA credit rating.
Preemptive Hikes Divide Experts
Advocates warn that acting fast on rates is crucial to break the inflationary feedback loop between businesses and households before expectations become entrenched.
Amid rising global inflation pressures, particularly from surging fuel prices, advocates for an OCR hike emphasize the urgency of preemptive action to prevent inflation expectations from becoming unanchored. Mark Lister highlights that businesses are already signaling intentions to raise prices, while households anticipate further inflation, creating a feedback loop that could entrench higher costs. This camp argues that nipping the inflation spike in the bud is essential even as New Zealand’s economy shows signs of stagnation, to avoid a more challenging environment for businesses, households, and investors down the line.
Supporters of early and gradual OCR increases caution against repeating past mistakes of delayed tightening, referencing the Reserve Bank’s slower response in 2021 and 2022. As Lister notes, a relatively swift rise from 2.25% to 3% in the OCR could mitigate the need for more aggressive and potentially disruptive hikes later. This approach aims to balance the delicate task of containing inflation without triggering unnecessary economic shocks, advocating for a measured but proactive stance in monetary policy.
Stagflation Dilemma Deepens
With inflation driven by global supply shocks and a stagnant economy, economists argue that standard rate hikes risk worsening the slowdown without tackling the root cause.
The Reserve Bank of New Zealand is navigating a complex monetary policy landscape where inflation pressures stem primarily from supply shocks, notably rising fuel prices linked to the Iran conflict, rather than from robust economic growth. As Mark Lister highlights, the typical economic strength that usually justifies the first OCR hike in a tightening cycle is absent, with New Zealand’s economy still grappling with stagnation, a neutral labor market, and slipping house prices. This scenario risks consumer spending pullback and squeezed business margins, as rising costs collide with subdued demand, potentially undermining confidence and local share prices.
Economic indicators underscore the frailty of New Zealand’s recovery, with the Services Performance Index expected to fall below the contraction threshold of 50 and inflation expectations climbing above 3.4%, fueling fears of stagflation. This dual challenge places the Reserve Bank in a precarious position, as it must weigh the inflationary threat from supply shocks against clear signs of economic slowdown, a dilemma compounded by the uncertain duration and impact of the Middle East conflict on oil prices. BNZ’s Stephen Toplis encapsulates this uncertainty, warning that the RBNZ’s policy decisions involve significant guesswork about whether inflation shocks will prove transient or persistent.
Voices from the economist community, including Kiwibank’s Jarrod Kerr and ANZ’s Sharon Zollner, urge caution, arguing that the current inflation surge driven by supply disruptions is fundamentally different from demand-driven scenarios like Covid. Kerr points out that the economy likely contracted in Q2, widening the output gap, and anticipates inflation peaking near 4.5% before easing to 2% by 2027, suggesting that premature OCR hikes could exacerbate economic weakness rather than contain inflation. Zollner’s metaphor that oil shocks place monetary policy 'between a rock and a hard place' captures the dilemma perfectly, highlighting the risk that rate hikes may not only fail to tame inflation but also deepen economic stagnation.
Learning from the aggressive and rapid OCR hikes of 2021-2022, the Reserve Bank appears committed to a more measured approach, preferring to move early and gradually to avoid repeating past mistakes. This cautious strategy reflects an understanding that the current inflationary environment, driven by supply shocks amid weak economic fundamentals, demands a delicate balancing act to prevent further erosion of consumer and business confidence while still addressing inflation risks. Such prudence aims to maintain flexibility in policy response as the Reserve Bank monitors evolving economic signals and geopolitical uncertainties.
Fiscal Strains Threaten Credit
Persistent deficits and delayed surplus targets are putting New Zealand’s AA rating at risk as fiscal flexibility shrinks amid mounting global and domestic pressures.
New Zealand maintains a strong AA sovereign credit rating, reflecting robust institutions and a wealthy economy, yet this standing faces mounting downside risks amid persistent fiscal pressures. The government’s commitment to returning to a budget surplus by 2029-2030 has been repeatedly postponed, largely due to tepid economic growth and shifting revenue dynamics, underscoring the challenges in balancing fiscal discipline with economic realities.
The country’s fiscal deficit remains elevated at around 5% of GDP, a level comparable to large economies like the United States and France, which raises concerns among credit rating agencies about sustainability. This high deficit, combined with the government’s delayed surplus target, signals ongoing fiscal strain that complicates the Reserve Bank’s monetary policy decisions amid global inflationary pressures.
Recent geopolitical shocks, particularly the Middle East conflict, have disrupted the anticipated economic recovery, prompting expectations of additional fiscal support measures in upcoming budgets. These interventions, while potentially necessary to stabilize growth, risk further delaying fiscal consolidation efforts and are being closely scrutinized by rating agencies for their impact on New Zealand’s credit outlook and fiscal trajectory.