Relieved by the drop in oil prices, the world economy continues to grow - ignoring all inflation warnings by the central banks and predictions of recession.
To add further fuel to the inflationary fire, the international labour markets remain tight and the threat of increased labour costs remains high.
Here in New Zealand the recent BNZ Confidence Survey shows pessimism has declined further with only a net 10% of respondents now feeling the economy will get worse in the next 12 months. This time last year it was 65% who thought the economy would get worse.
Housing confidence is also up. The ASB Housing Confidence Survey sums up the current feeling as “people appear to remain comforted by the recent experience of lower house price appreciation, and slightly longer sales periods, judging by more thinking now is a good time to buy”.
Most significant is “The number of people who believe now is a good time to buy exceeded the numbers who believe it is a bad time for the second quarter in a row – a rare event in recent years.”
So the housing market is still relatively strong but it looks like the hype of 2003 has finally dissipated. And most of the very low fixed rate mortgages taken out two or three years ago will now be at the new rates and people still seem to be coping.
The latest statistics show the September quarter unemployment rate increased to 3.8% from 3.6% in the June quarter. But this is close to the historic low of 3.6% and is still well below the 6.3% long term average. The number of people employed is the second highest recorded here and shows the labour market remains tight by historical standards.
Both wage inflation and the labour market have eased slightly, but not by much. Slower growth in the economy will eventually ease the demand for labour but it now looks like this will take longer than originally thought.
So while lower petrol prices and a more subdued housing market – admittedly helped by a change in the way the CPI is measured - have eased inflation, the tight labour market suggests the Reserve Bank will still be nervous. And while they did not raise The Official Cash Rate last month, will at least hold it at the current 7.25% level for some time yet. The 10 year average is 6.2%.
These fears of inflation are not restricted to New Zealand.
The Reserve Bank of Australia increased its cash rate by 0.25% to 6.25% on Tuesday - the third increase this year. The RBA has raised the cash rate eight times since May 2002, when the rate was 4.25%. It said it made the decision “against a background of continued expansion in the global economy and further evidence that inflationary pressures had increased”.
Glenn Stevens, the Reserve Bank of Australia Governor, said “Labour markets have remained tight and businesses are reporting high levels of capacity usage.” There unemployment has been steady at 4.8% for some time now but yesterday’s figures showed a fall to 4.6%. That’s a 30 year low.
In the U.S., the unemployment rate fell to 4.4% from 4.6% - the lowest since April 2001. As long as the unemployment rate is falling and rising labour costs look threatening, the US Federal Reserve will not be thinking of interest rate cuts. In fact, this week two members of the Federal Reserve have commented that another interest rate increase may be necessary if inflation pressures don’t subside.
The Bank of Japan raised interest rates to 0.25% in July – the first time in six years. They left rates unchanged in October but this week the head of the Bank of Japan, Toshihiko Fukui, hinted that interest rates may rise as inflation pressures increase.
“We must not take a long time to adjust policy interest rates” he said. Optimism there was in danger of causing major swings in the economy. He implied that it would be too late to raise interest rates after prices and the economy started picking up.
This morning the Bank of England increased interest rates to 5.0% - a 5 year high. There’s differing opinion as to whether there will be a further rise in the New Year.
And the European Central Bank has said if the economy performs as expected, there would be little doubt that interest rates would increase further.
So what does all this mean?
In New Zealand the Reserve Bank faces the problem that increases in the OCR are not having the immediate effect of taming the housing market, but are increasing the demand for our currency through the likes of the Uridashi and Eurokiwi issues.
Governor Alan Bollard only yesterday publicly spoke of the risks to New Zealand of the heavy concentration of wealth in housing.
But now there is a growing view that RBNZ has raised interest rates for the last time - albeit they won’t reduce them for a long time. Even Michael Cullen has got into the act, saying in London in late September “The general consensus is that rates will not be raised, but that the beginning of the easing part of the cycle has been pushed off further into next year, possibly even into early 2008”.
Meanwhile tight labour markets and other inflationary pressures still remain in other countries and the central banks have either increased their cash rates or have threatened to do so.
This means the gap between the interest rates set by central banks in other countries - and the RBNZ - is narrowing and other interest rates should follow.
You would have thought that when the RBNZ did not raise the OCR last month it would have put downward pressure on our currency. In fact it did not – reaching over 67 U.S cents – and still remains at 66.5 U.S. cents now.
Of course the spread between the central bank rates is still good but this - thankfully - shows factors other than our high interest rates attract foreign money. Maybe an economy that is still strong in a removed stable country, like New Zealand, is an attractive proposition.
And while the dollar is higher now than what you’d have thought, anyone hoping for the sort of drop anticipated before – like to US$50 - will be disappointed.
The economy is in a healthy position and the demand for commercial property remains strong. Yields are still historically low and as interest rates rise should start to be more realistic. But right now the demand outstrips supply.
I’m of the view that well located residential property will continue to be in demand but still have my doubts about inner city and serviced apartments, or subdivisions in questionable locations.
At Global Pacific we’re seeing a far more critical view by financiers on the saleability of the end product of developments. There’s clearly an over supply of certain stocks in certain areas.
Cheers
JP
John Paine B.Sc. Dip BIA
Global Pacific Corporation Limited
112 Gladstone Road, Parnell,
P O Box 3229, Auckland, New Zealand
Phone 64 9 303 3700, Fax 64 9 303 3031
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