Official Cash Rate explainer: Why interest rate hikes are the go-to response

Kiwis are bracing for more financial pain after the latest Consumer Price Index showed inflation is remaining stubbornly high.

For the average person, the past year has probably felt like an endless barrage of higher costs. Whether it’s food, housing, petrol or your mortgage it can feel like everything is getting more expensive and unfortunately, that’s because it is.

On Tuesday Statistics New Zealand released the CPI figures for the September quarter which showed annual inflation increased by 7.2 percent – down just 0.1 percent from the June peak of 7.3 percent.

The figures were significantly higher than predicted with many experts expecting inflation to be around 6.5 percent. And the higher-than-expected inflation prompted concern and warnings from economists.

It will also most likely prompt another hike to the Official Cash Rate (OCR) which will mean more pain for homeowners.

Inflation began rising in March 2021 jumping from 1.5 percent to a whopping 7.3 percent in June of the next year. As a result the Reserve Bank of New Zealand (RBNZ) began hiking the OCR – making borrowing more expensive – in an effort to force Kiwis to spend less to reduce demand.

The RBNZ first increased the OCR by just 25 basis points from 0.25 to 0.50 in October 2021. From there the hikes continued until it hit 3.5 percent just a year later. Further increases are also expected in response to the latest CPI figures.

But for most people, interest hikes hardly feel like a solution when it just means more financial pressure amidst a cost of living crisis.

With more people facing mortgage pain, is hiking interest rates the best way to solve inflation or just another excuse to squeeze the average Kiwi out of their hard-earned cash?

Newshub investigated why OCR changes are the go-to response to inflation and what the alternatives are.

Why is inflation high?

The first thing to understand is what is actually causing inflation. While it’s hard to pinpoint exactly what’s to blame, New Zealand has been facing a perfect storm of inflationary pressures over the past year. Including pent-up demand post lockdowns, labour shortages, increased manufacturing costs, supply chain issues from the pandemic and an influx of Government financial support. This culminates in the main driver of inflation – demand outstripping supply.

The latest CPI figures show housing and household utilities were the main contributors to inflation – increasing by 8.7 percent since September 2021.

This was mainly influenced by higher prices for home ownership, up 3.3 percent, and property rates and related services, up 7.1 percent.

Transport was the second most significant contributor to the annual increase up 12 percent driven by a 19 percent increase in petrol.

The increase in the cost of food also contributed, with food prices up 8.0 percent annually. The largest contributors to this were grocery food (up 8.0 percent) and fruit and vegetables (up 14 percent).

Why are OCR changes the go-to tool to manage inflation?

While it might feel like New Zealand has no control over many of the price rises such as petrol, Infometrics principal economist Brad Olsen said we actually have more control than we think.

Some of the inflation in New Zealand is caused by external forces, such as the war in Ukraine, but Olsen said there are enough things we can control to justify OCR increases.

For example, Olsen said OCR hikes will bring the cost of building a house down because New Zealand produces most building materials here.

He said currently we can build roughly 35,000 to 40,000 houses a year but low-interest rates saw building boom with the country currently trying to build more than 50,000.

“So you’ve got an extra 25 percent on top of normal capacity that we’re trying to build. And that has directly been stimulated by very low-interest rates which have put up house prices and the house prices go up, every developer under the sun goes, ‘Man, I’m going to make a mint if I build a house and sell it off’.

“So you’ve generated a huge amount of additional demand with those lower interest rates, which is what the lower interest rates were designed to do.

“Now the higher interest rates are designed to kneecap that and say, ‘Actually, no, we don’t need as much. We can’t sustain as much demand for those sorts of products. So we need to bring them down’.”