Inflation, what is it?

We are hearing a lot about inflation in the news recently, but what is it? Inflation simply means the rate at which prices are increasing.  If inflation is high, it means that prices are increasing quickly.  

Right now inflation is sitting at 7.3% which is considered high. That should come as no surprise, with visits to the petrol station and the supermarket clearly more costly.

Inflation is driven by a variety of factors, one of these factors being the high level of employment. As more people have jobs, they can usually afford to spend more. This influx of spending may encourage suppliers to increase their prices. We are also seeing the impact of some goods only being available in limited quantities. For example, shipping has been disrupted during COVID, which means Aotearoa does not receive the goods it normally would from overseas – this limited supply also encourages prices to go up.

The Reserve Bank of New Zealand – Te Pūtea Matua is New Zealand’s central bank. One of their key focuses is controlling inflation, with a target of between 1-3%.

With inflation sitting well above their target, how do they slow it down?

One tool the Reserve Bank uses is the OCR (Official Cash Rate).  This is an interest rate set by the Reserve Bank, and it has a big influence on the interest rates that banks (like BNZ, ANZ, ASB and Kiwibank) pay when they borrow money.

If the Reserve Bank wants to reduce inflation, as it does now, it will increase the OCR.  This means the banks are now paying a higher interest rate for money they borrow, and they will look to cover this increase by charging a higher interest rate when they lend money to all of us.  Mortgage interest rates, vehicle finance payments, credit card repayments – they all increase. As people are spending more to meet their interest bills, they have less to spend at the shops. This results in lower demand for goods and services, discouraging suppliers from increasing the price of those goods.

We can see this happening now with house prices.  Higher interest rates mean there are fewer people who can afford to buy houses, so we are no longer seeing an avalanche of prospective buyers at every house auction – and house prices have fallen. This is exactly what the Reserve Bank is trying to achieve, but not just across house prices – they want to see this impact across normal everyday items too.

The Reserve Bank has clearly stated its desire to bring inflation under control, so we have not seen the end of increases in interest rates, and we all (households and businesses like Whai Rawa too) need to take this into account when planning ahead.