Hamish Rutherford: Hot labour market good for workers, but problems ahead

Reserve Bank governor Adrian Orr. Photo / Mike Scott

OPINION:

In terms of problems, an overheating labour market falls into the category of a good one to have.

But a shortage of labour, coupled with rising inflation pressures and asset prices, means it is a problem nonetheless.

Conditions in the housing market are already unsustainable; prices have risen 30 per cent in the past year in many parts of the country.

Inflation pressures are rising and increasingly looking like they are persistent. Energy costs, in particular, are likely to impose rising costs on households and businesses for years.

Now, the unemployment rate has fallen to a level where it is creating pressure for significant pay increases.

"Spare capacity in the labour market is dwindling, which can potentially result in tighter labour market conditions and lead to upwards pressure on wage rates," a Statistics New Zealand spokesman said.

This is great for workers in the short term, but, unless there is an increase in productivity (and there isn't) it is another key driver for pushing up costs as employers try to recoup the added costs of their wage bills.

Wage pressures beget cost of living increases causing pressure for more wage increases. Just because New Zealand has not seen significant inflation for a generation does not mean it will be less painful if we get into a spiral.

Even before Wednesday's release, it seemed likely the Reserve Bank would respond to the increasing pressure by raising the official cash rate (OCR).

New unemployment figures confirm New Zealand is short of labour, which is adding to wage pressures. Photo / Michael Cunningham

Now, the last few who predicted governor Adrian Orr could afford to wait longer than the next meeting of the monetary policy committee later this month are silent. Few seem to now doubt the New Zealand economy is overheating.

The question is how many times Orr will have to announce he is hiking interest rates?

Bank economists now seem to expect three before the end of the year; ANZ reckons there could be as many as five in less than 12 months.

This will amount to a severe tightening in financial conditions at a time when households have taken on a mountain of debt.

Earlier this week the Reserve Bank said there was a "problem" with high loan-to-value lending in the past 12 months which could leave some recent buyers in negative equity.

Orr has never increased the OCR since becoming governor. The Reserve Bank has not increased the cash rate in more than seven years.

The last time it hiked the cash rate by more than 1 percentage point in a year, the OCR was 5.25 per cent, meaning the added imposition on mortgage holders was relatively smaller.

Adding more than 100 basis points to borrowing costs to an overheating economy could cause severe pain for many households.

The problem is, the Reserve Bank has little option but to do it.