Early indications suggest it could be really bad for house prices.
Ever since February 28, when US-Israeli forces launched a surprise bombing campaign that killed Iranian leader Ali Khamenei along with other top officials and civilians, the world economy has been in a state of tumult.
Iran responded by attacking other gulf states and closing the Strait of Hormuz, triggering a global fuel crisis. The wholesale spot price for crude oil has jumped from around $69 a barrel to a high of $111.
While everyone’s eyes have been on the price of petrol, the Strait of Hormuz is also an important shipping lane for many other important commodities – notably liquid natural gas and fertilisers such as nitrogen-based urea and ammonia. This has already caused price spikes for food commodities including corn, soybeans, rice and sugar.
For house price-obsessed New Zealanders, this might be the scariest statistic of all: Since the war began on February 28, the 3 year swap rate has jumped from 3.19% to 3.93%.
What does that mean? It means the smart money is betting that interest rates are going to go up in response to inflation. Effectively, the market has priced in three OCR increases in less than a month. If that turns out to be the case, it will mean higher mortgage payments, more financial stress for homeowners, lower house prices, and a really bad time all around for the New Zealand economy.
This is not unique to New Zealand. Across the world, markets have reacted in much the same way. According to BNZ’s Jason Wong, investors are “concerned about the risk of a prolonged war adding to inflation, pressure on fiscal accounts, and central banks needing to counter the impact with tighter policy.”
However, not everyone agrees with the collective wisdom of the market. Kiwibank’s chief economist Jarrod Kerr wrote on Monday that “we completely disagree with market sentiment. We see hikes as infeasible for the RBNZ, given the immense demand shock that the oil disruption brings to the Kiwi economy”.
There has been much speculation about how the Reserve Bank will respond to war-driven inflation. The most recent quarterly figures, from before the war began, had inflation at 3.1%, slightly above the legally-defined inflation targets of 1-3%, which put the bank in a tricky position.
At a BusinessNZ breakfast event on Tuesday, Reserve Bank governor Anna Breman gave the first major indication of how she expects the war in Iran to affect the New Zealand economy. She made it clear that the bank was taking a “forward-looking” approach and wouldn’t overreact to short-term price changes.
Breman split the economic fallout into two categories: “first round effects” – the immediate price spikes in petrol, food and fertiliser – and the harder-to-predict “second round effects”, where prolonged inflation or weakened growth start to reshape the broader economy.
“Tightening monetary policy in response to a short-lived disruption would only dampen growth without materially improving near-term inflation outcomes,” she said. In other words, if we cross our fingers maybe the war will resolve itself and the petrol price spike will just be a blip.
Compared to the last time crude oil jumped to over $100 a barrel – the start of the war in Ukraine in 2022 – the economy is in a much more sensitive position, only barely starting to recover. A major increase to the OCR could be disastrous. However, if inflation looks like it will stick around for the medium-to-long term, “the appropriate policy response could be to increase interest rates to prevent these second round effects,” Breman said.
However, there are plenty of things that give the Reserve Bank reason to worry. The New Zealand dollar has dropped by 1.5% since the war began; an expected move during times of uncertainty, which makes imports more expensive. This will be particularly noticeable for food grown in the northern hemisphere, as it could take as long as nine months for the fertiliser costs to fully pass through to supermarket prices for some foods.
A lower dollar is usually good for exporters, but it’s not all good news there either. Countries in the Middle East buy about 4 to 5% of our exported goods and services, and losing access to those customers will affect New Zealand. In other markets, especially China, could also be affected as oil prices and/or economic recessions force buyers to tighten their belts. The Reserve Bank also expects weaker international tourism due to increased costs of jet fuel and airfares.
As public servants, Reserve Bank governors typically shy away from political statements, but one line at the end of Breman’s speech jumps out as a direct challenge to the government: “Fiscal policy, not monetary policy, is best placed to provide targeted support to households who are the most vulnerable to these price increases.”
Up until the past few weeks, Nicola Willis and Chris Luxon’s economic strategy has been built around the Reserve Bank coming in to save the day with economic growth driven by low interest rates. This speech from Breman pushed the onus back onto the government. The government responded on Tuesday afternoon by announcing a fuel relief package announcement. The question now is: will it be enough?
