Intensive care interest rates

OPINION: Is inflation dead? The answer is no, and it is probably not even in palliative care. However, it is poorly enough to be in the intensive care unit and to have its few loved ones gathered around with concerned looks on their faces.

Inflation’s potential demise is an important question. Ultimately, the amount of inflation dictates what you will pay for a mortgage and what investment returns you will get on your savings.

Inflation drives interest rates and interest rates flow through to the health of the economy. The performance of your business, or whether you are likely to see your wages increase, will depend very much on what happens to inflation. Inflation is important.

Like the rest of the world, New Zealand has a very strong economy. We have a low unemployment rate and in most major economies of the world, unemployment is either low, or at least tracking down. Normally, that would mean rising inflation and interest rates – but they have both remained low.

So, what’s going on? Why is inflation laid low at an economic time when we would normally expect it to be up and dancing?

There is a range of factors holding down prices, from demographics to the demise of the unions.  However, perhaps the biggest factor in one form or another is technology. First, automation is starting to reduce costs in many businesses.

For example, the cost of a welder at Ford Motors is US$25 an hour, but for a robot it is just US$8 per hour (including installation, operating and maintenance). According to BCG, the cost of that robot may fall to US$2 per hour by 2030.

Second, e-commerce (Amazon and the likes) means that we can easily compare prices all over the world and buy the cheapest. A book used to cost my household $30 – $40. Now, without ever leaving the house and with just one click, I have them instantly delivered to my PC for less than $10.

Third, fracking and other oil recovery methods have increased the supply of oil and gas, which in most countries (not New Zealand), has sharply lowered the price at the pump. Five years ago, in the USA, a gallon of regular was US$3.80 – today it is less than US$2.40.

Fourth, is the sharing economy (e.g. Uber, Airbnb). These platforms have effectively delivered car rides and hotel nights cheaply and without having to build new cars or hotels.

Technology is keeping a lid on prices. This is not a part of the old up-and-down economic cycle when central banks had to rush around raising and lowering interest rates but a change which is structural.

The chances are inflation will remain on its sick bed. There will be interest rate rises but they are likely to be small and no-one should expect interest rates back at 9 per cent any time soon.

Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. He is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.

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