Liam Dann: Are the central banks being too hawkish?

OPINION:

Central banks are in danger of causing an unnecessarily hard landing by hiking rates too far and too fast.

They seem to be reacting to intense pressure from an older generation that is fearful
of a return to the inflationary days of their youth.

But if central banks overdo it, the economy will crash and younger generations will suffer.

Right now we are in the most precarious part of the post-pandemic recovery.

Financial markets are manic. Commodity markets aren’t much better.

Tiny bits of news that don’t tell us anything new – like a US Federal Reserve official reiterating that inflation is bad – are having outsized impacts on sentiment.

One day Wall Street is up 2 per cent and the next it’s down 2 per cent. That’s not healthy market behaviour.

The volatility highlights risks that the US Federal Reserve could overplay its hand and spark a financial market meltdown and global recession.

Economic narratives have a habit of taking hold and spiralling until they are no longer well grounded.

There’s a good case to be made that this happened in the initial wake of Covid.

The worldwide pandemic was unprecedented in living memory, assumptions were made about what it would do to economic demand.

A fearful narrative took hold, resulting in what – with hindsight – was too much stimulus for too long.

While the rapid end of monetary stimulus and steep rise in rates was clearly needed, the momentum now is so hawkish that we risk over-correcting.

Central bankers are engineering an economic downturn to bring supply and demand back into balance.

It is a complex piece of economic surgery which, as usual, they have to do with a hammer.

We need to see inflation peak and ease.

But a financial crash, or deep recession, would be a disaster in a world where pandemic stress has already stretched society into dangerously fragmented territory.

You can see the script unfolding with ominous predictability.

The US Fed is raising rates in 75 basis-point hikes and last week the RBNZ revealed it considered doing the same.

Interest rates have already been hiked at an unprecedented pace in the past 12 months.

In New Zealand, we’ve seen eight hikes in a row – five of them by 50 basis points.

Another 50-point hike is almost certain in November, which will take the cash rate to 4 per cent – the highest it has been since the global financial crisis.

But, because most people are on fixed mortgage rates of one or two years, we are only just starting to see the impact of these hikes on the economy.

According to the latest Reserve Bank figures the average fixed rate mortgage was still just 3.68 per cent as of August.

That suggests almost all the real interest rate pain is still ahead of us.

First, the higher rates have to hit people in the pocket, which dampens economic demand and then flows through to inflation.

While we await hard data on inflation later this month, economists are digging into more nuanced information for clues.

There have been some signs that the current inflationary cycle is peaking.

The ANZ Business Outlook, NZIER Quarterly Survey of Business Opinion (QSBO) and the SEEK NZ Employment report all indicate that capacity pressures in the labour market are starting to ease – albeit slightly and from record high levels.

As a topline comment on the QSBO, NZEIR principal Christina Leung noted that “business is starting to see some light at the end of the tunnel.

A reader called Ian wrote to me.

“Hi, I worked in the rail for 40 years and we were always worried that the light at the end of a tunnel could be a train coming the other way.”

That succinctly sums up the risk here and around the world.

The economy right now is actually a good one for young people who don’t yet have mortgages.

They have jobs and job mobility. They are using that mobility to advance themselves and their earning power.

Wage growth is running ahead of inflation, at 8.7 per cent.

That’s not because companies are offering up 8 per cent annual pay reviews – but because young people are able to move jobs and get promotions.

Clearly, this isn’t such a good economy for us older folk, who don’t have the same levels of job mobility and capacity to boost our incomes.

What worries me is that older people dominate the political and economic narrative.

Calls for ever more hawkish central bank policy show a lack of appreciation for the value of high employment and the long-term benefit it brings to the next generation of New Zealanders.

As a quick reminder, the whole hawks and doves thing is borrowed from the language of foreign policy – as it relates to an appetite for aggression and war.

Hawks of war, doves of peace.

In economics, it’s all about monetary supply and attitudes to inflation.

Hawks support higher interest rates and a more aggressive inflation-fighting stance, doves are more relaxed about inflation and generally argue for leaving rates lower.

I am suspicious of anyone who sees them self-steadfastly in one camp or the other, as I am with the most tribally minded on the left and the right of the political spectrum.

I have been feeling increasingly hawkish for about 18 months.

But it feels like the time is approaching for the hawks to breathe through their nose for a bit (or their beaks).

Across the Tasman, we saw the Reserve Bank of Australia do just that last week, surprising the market with a softer than expected, 25 basis-point hike.

Perhaps RBA Governor Philip Lowe is also suspicious about that light at that end of the tunnel.