13 Sep 2021
It’s no secret the cost of living in New Zealand has increased sharply in the past 12 months with inflation now over twice the 2 per cent midpoint of the Reserve Bank of New Zealand’s (RBNZ) 1-3 per cent inflation target range.
Through the health, fiscal and monetary policy responses to COVID over 2020, the economy has avoided the extended and deflationary economic recession initially feared when we went into lockdown for the first time.
“Since Q2 2008, living costs for the top 20 per cent of earners have risen 20 per cent but for the lowest 20 per cent, the increase has been 30 per cent.”
But Kiwis are now in a situation where domestic demand is roaring ahead while supply remains hobbled by materials and labour shortages and disruptions to domestic and global supply chains. As a result, inflation (as measure by the annual increase in the Consumers Price Index – CPI) rose to 4.9 per cent in Q3 2021. Both ANZ Research and the RBNZ expect inflation will get worse over the next few quarters before things start to settle down. In fact, ANZ Research now expect inflation was 6 per cent in the December quarter.
While this overheated economy is better than the alternative – an economic recession - it’s still tough going for household budgets to make ends meet at a time like this.
The Household Living-Cost Price Indexes (HLPI) published by Stats NZ show how living costs are rising for different types of Kiwi households – including by differing income and other social indicators. Because households have very different spending patterns, the HLPI for each type of household is weighted to reflect that.
For example, the 2021 expenditure weights calculated by Statistics NZ show 16.4 per cent of expenditure for the lowest-income households went towards rent payments compared with just 6.7 per cent for those on higher incomes. When the price of renting goes up it has a larger impact on the cost of living (and HLPI) of lower-income households than for higher-earnings ones.
Households have historically had varied experiences of inflation. Over most of the last decade, beneficiaries and superannuants saw their living costs rise at a faster rate than average. This matches expectations from data by household income – the 20 per cent of households with the lowest incomes have tended to see the largest living cost increases while the richest 20 per cent have seen the smallest increases.
The cumulative impact of higher cost increases for some households is actually quite significant. If we plot the level of the HLPIs across income quintiles it’s clear how much more costs have increased for low-earning households.
Since Q2 2008, living costs for the top 20 per cent of earners have risen 20 per cent but for the lowest 20 per cent the increase has been 30 per cent. Superannuants have had it the worst in terms of the rising cost of living with costs up 34 per cent over the same period.
In a break from historical patterns, cost increases have been of about the same magnitude for all households in recent quarters. That likely reflects the fact inflation has been very broad-based – the only component of the CPI that didn’t rise in Q3 was communication (just under 3 per cent of the total basket).
On average, households saw living costs rise 4.0 per cent in the year to September 2021. That’s obviously lower than the 4.9 per cent CPI print in Q3 and reflects how the HLPI is constructed slightly differently. For example, interest payments are not included in the CPI and, given recent OCR cuts, these have been at a very low level recently. But the super-low interest rate boon is over. The RBNZ has now lifted interest rates twice with ANZ Research forecasting more to come in order to combat surging inflation. But don’t expect cost pressures to moderate on an annual basis until well into 2022 – the inflation dragon is well and truly awake.
On paper it looks like everyone’s hurting from the same strong inflation currently. But when digging into the details it’s clear, for poorer households, high inflation is particularly hard to deal with.
The biggest drivers of strong inflation in recent quarters have been housing, transport and food. Of the 2.2 per cent increase in consumer prices in the September quarter 2021, 0.7 percentage points came from housing (eg rents, building costs, council rates), 0.5 percentage points came from food, and transport added 0.5 percentage points – with 60 per cent of that from petrol alone.
These are all essential items - and that makes absorbing price rises more difficult for poorer households since a larger share of their expenditure goes towards essential goods and services.
It’s easier for higher-income households to cope with price rises because they can simply cut back on more discretionary spending such as not dining out as much. For a poor household whose budget can barely cover the essentials even when inflation is low, the choice quickly becomes: do I have lunch this week or pay the rent?
Looking at the composition of household spending across different income groups, for the bottom 20 per cent of households in New Zealand, housing, food and transport make up a much bigger share of their expenditure than for the top 20 per cent.
For wealthier households, interest payments make up a larger share of their expenditure because they’re much more likely to have a mortgage on an owner-occupied home (and/or investment property).
Adding up the numbers, 63.5 per cent of expenditure goes towards food, housing and transport for lower-income households compared with 51.2 per cent for the highest earners. And that underweights the importance of ‘essential’ spending for poor households since they also have to fork out for essential clothing and footwear, insurance, health, education and other items – which have all gone up in price. Plus, within groups like food expenditure, higher-income households tend to spend more on more ‘optional’ items like restaurant meals and takeaways.
The bottom line is for poorer households who spend a lot more of their constrained budgets on essential goods and services, the current composition of strong inflation is particularly hard to bear. Higher-income households may be able to more easily absorb price rises by simply cutting back on non-essential spending but for poorer households there’s simply not much fat to trim.
Unfortunately, the tonic for overly high underlying inflation is higher interest rates, which isn’t a barrel of laughs in a net-debtor economy either.
ANZ Research is forecasting the RBNZ will continue to lift the official cash rate (OCR) in 25 basis point increments to a peak of 3 per cent in early 2023 – and expect that will be enough to bring CPI inflation back to a more-manageable level.
Hiking interest rates might seem like a challenging proposition when businesses are struggling against COVID restrictions, labour shortages and supply disruptions while house prices are forecast to fall about 7 per cent over 2022. But CPI inflation is too strong – and the labour market is so tight it’s only worsening the surge in cost pressures. So further interest hikes will be needed to bring rampant inflation back under control. It won’t be fun – the outlook for economic growth is pretty soggy given how supply-constrained things are. But that’s why central banks are independent – to make the tough decisions for the long-term health of the economy.
And higher interest rates should be pretty effective at putting a lid on the frothy economy. Mortgage rates have already risen sharply as expectations for future interest rate hikes flow into wholesale and then retail interest rates. The 1-year special mortgage rate dropped to a low of 2.21 per cent in June 2021 and as of November was about 130bps higher at 3.49 per cent. If a hypothetical household with a $NZ800,000 mortgage experienced the same increase in their mortgage rate then, all else being equal, their weekly payments would increase by roughly $NZ115 (assuming a 25-year mortgage).
That’s going to hurt. And when you multiply across hundreds of thousands of borrowers, it’s a lot of disposable income suddenly taken up with increased mortgage payments.
So how could this possibly make things better for households? It will certainly be a rough adjustment for some – especially those who have leveraged up to the hilt to jump into the frothy housing market over the past year. But it’s worth noting that, overall, interest payments are just 2.7 per cent of expenditure for lower income households and 6.2 per cent for the highest earners.
Debt servicing has become more expensive (and will likely continue to in coming quarters) but out-of-control inflation would deal a much more devastating blow to household purchasing power. And of course, some households are net savers - particularly older ones - and stand to benefit from higher interest rates.
Kiwi households have around $NZ210 billion on deposit at banks in New Zealand versus $NZ326 billion of mortgage debt. That’s a decent offset but overall Kiwis have a tendency to spend beyond our means - as demonstrated in our persistent current account deficits - so higher interest rates do suck income out of the economy overall.
High inflation is not just a theoretical problem, it’s a real problem - especially for low-income households. And while the medicine (higher interest rates) isn’t pleasant for borrowers, it’s far better than seeing living costs spiral out of control and real incomes collapse.
Kiwis have spent a long time getting used to low and stable inflation so it’s worth remembering high inflation can be extremely damaging. That’s why the RBNZ has acted (much faster than many of its international peers) to protect the value of money in New Zealand.
Because that’s what inflation does: it erodes the value of money.
Finn Robinson is Economist and Sharon Zollner is Chief Economist NZ at ANZ
This article was originally published by ANZ Research and has been edited for length.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
13 Sep 2021
05 Aug 2021