Monetary policy tightens its grip on the economy

Monetary policy tightens its grip on the economy

Hand gripping on to ropes

Maybe this doesn’t apply to you. But speaking personally, I find the feeling of panic sometimes to be quite exhilarating and worth running with for a while before letting logic back in, calming down, and turning back to see it was just the cat after me and not the black leopard apparently roaming our countryside.

In the financial markets and amongst people buying and selling assets such as shares, panic can sometimes arise quite quickly and lead to big price changes before the sane voices start to be heard over the roars of anguish. We have perhaps just seen an example of this in the wholesale interest rate markets where banks raise money at fixed rates to lend to you and I when we want a fixed rate mortgage.

In early June the average cost to a bank of borrowing money at a fixed rate for one year was 3.6%. Three months later it was 4.2% mainly in response to rapid tightening of monetary policies offshore (notably the United States). Come two weeks ago the rate was 5.25% following the higher than expected inflation outcome for New Zealand of 7.2%.

Discussions swirled regarding the need for much tighter monetary policy, the need for recession and a big jump in the unemployment rate and coming woe for mortgage holders as house prices fell a lot further.

But things have calmed down a bit now

The borrowing cost has retreated to about 5.05%. Banks will be happy about the initial surge because it allowed them to push through 0.5% or so increases in fixed lending rates as it became obvious to all that lending rates in place then were completely unsustainable.

They will also be happy about the subsequent pullback in wholesale borrowing costs because that has improved margins further – though they are still 0.6% or so below average levels of the past two years.

We should not rule out the possibility of some more small declines just because the labour market numbers released this week were slightly stronger than expected.

The 3.3% unemployment rate was close enough to forecasts of 3.2% to be ignored. But the 1.3% jump in job numbers during the September quarter was far stronger than expected.

The NZ labour market is tight. But it is also something which lags changes in the pace of economic growth.

That is, wages and jobs growth will be amongst the last things to change as tightening monetary policy gets its true grip on the economy and forces inflation lower.

We can see part of that grip emerging with anecdotal reports from recruitment agencies of a falling off in demand for new staff. Partly that is because corporates are catching up on restructuring delayed for two and a half years because of the pandemic.

But the main sign of higher interest rates comes in the results of my latest monthly Spending Plans Survey sent to the 29,000 people who receive my weekly Tony’s View publication. With about 1,000 having replied we can see that a substantial decline has just occurred in the net proportion of people who say they plan spending more on things generally over the coming 3-6 months.

I won’t reveal the exact number as not all results are in yet. But suffice to say the latest round of mortgage rate rises may have hit the (bad) sweet spot in the household sector with spending plans now at their lowest level for the two and a half years during which I have been running the survey.

For retailers this is bad news.

But it is exactly the bad news we need to see

That's because crunching household spend is the main path by which tightening monetary policy eventually throttles high inflation. My data and the employment anecdotes won’t dissuade the Reserve Bank from raising the official cash rate another 0.5% at least come November 23. But it is entirely possible that their comments do not express the same degree of panic about inflation as seen recently in the interest rate markets.

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