Cost Impact – Inflation, Interest Rates and Real Estate

The Global economy landscape is completely different compared to the last 2 years as concerns about inflation, market downturn, and the likelihood of a recession continues to be the most discussed topics in the today’s markets. With so many moving factors it can be difficult to make sense of how it all connects and it begs for answers for the most frequently asked, will there be a recession? Where interest rates might taper off? Why is the inflation rate still running wild after several interest rate hikes? Lastly, how does this affect investments? All are questions this article aim to address. 

Let’s first deal with inflation – by definition, inflation as the rise in prices of goods and services in an economy. This is identified by what is called the Consumer Price Index (CPI), which measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. In July 2022, The Statistical Institute of Jamaica (STATIN) reported that the CPI increased was 0.7% bringing inflation since July last year to 10.2 percent, the government agency stated. The July 2022 inflation comes in well under the 1.7 percent increase in July 2021 but in line with the Inflation for June last year of 0.7 percent.

In September 2022, the CPI index increased by 1.4 per cent, this upward movement was largely resulting from a 4.1 per cent increase in the index for the division ‘Housing, Water, Electricity, Gas and Other Fuels’. One can see that there is a high differential for the period July – September 2022 which shows how quickly cost is climbing. In the U.S., the inflation rate also measured by the Consumer Price Index was 8.5%. That means the costs of goods raised by an average of 8.5% year-over-year though not all goods and services were equally impacted by inflation, categories such as food and energy experienced the largest hikes.

The significant price increase over the past year have been caused by several factors — the ongoing war in Ukraine which caused significant increases in energy cost, supply chain challenges which  affecting costs to import goods and other commodities are the key drivers for inflation which eventually find its way to consumers. In other words, high prices are being caused by the delaying of goods which creates the problem of shortage thus causing a significant imbalance between levels of demand and supply thus resulting in inflationary pressures.

Interest rate is the cost of money therefore, inflation increases as a result of rising prices of goods and services then interest rate (cost of money) must also move in the same direction until there is some level on containment. This is where the Bank of Jamaica (BOJ) steps in – one of its core objective/responsibility is to maintain a low inflation and unemployment rates in the economy which it does by controlling policy (interest) rates. Effective 30 September 2022, the BOJ increased interest rates by 50 basis points to 6.50 per cent per annum from 6.00 per cent per annum. The increase marked 500 basis points (bps) between the end of September 2021 and the end of July 2022, while the weighted average deposit rate offered by deposit-taking institutions (DTIs) to the public has increased by only 37 bps. Such increase makes it more expensive for banks, individuals and businesses to borrow money. By keeping rates low it encourages more businesses locally to invest which will ultimately improve economic growth.

While for consumers, higher interest rates mean it’s more expensive items that are most times facilitated through borrowing such as motor vehicles and real estate. This also affects credit card rates therefore; you may end up seeing a higher annual percentage rate on your credit card. That means that consumers who carry revolving debt on their credit card could see higher interest charges on their monthly statement.

High interest rates resulting from significant cost increases’ coming out of the COVID-19 pandemic is currently being experience by most countries. Many have been handling this through the use of monetary policy methods of managing policy rates. In doing this it helps to reduce the overall level of demand which should therefore slow down the upward pressure on prices. This means consumers and businesses in the long run will start spending less and demand will come back down to a level that’s commensurate with supply.

This brings us to the topic of recession. Will there be a recession? A recession is a period of two successive quarters of economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP. When there is reduced spending and investment in an economy, businesses may respond to consumers purchasing fewer goods and services by reducing production. If productions are reduced then you’re likely to potentially see a hiring freeze and/or layoff which could then push the unemployment rate up. All of these factors are what eventually causes recessionary environments. But rates cannot just continue to rise because there is a point at which it all breaks even. Though rates are increasing, policy makers are still aiming to foster growth in the economy by maintain the most feasible range which will allow time for recovery.

Consensus says that a global recession is likely sometime in 2023, but it is impossible to predict how severe it will be. For the record, I do not think it will be severe because markets are resilient than previously, nor do I expect it to persist. However, there will be few more interest rate hikes within the global environment, Jamaica included. In my opinion, it will take at least two/three quarters for consumers and businesses to respond with lower demand and production. The BOJ has done a very good job so far in keeping rates below unprecedented levels which have surely taken its lagging effect on inflation. However, this is still higher than targeted and will take a long time for us prices to adjust.

The bottom line is many economies will not feel relief from higher prices until supply chain bottlenecks resolve or geopolitical issues in Ukraine are eased. This could very well persist until the year 2024/25 but there will be containment between interest rates and inflation.  But until then how will this affect you and your investments? Stay tuned for part 2!

Article written by:

Orick O. Angus

Wealth Manager, Ideal Securities Brokers Limited

Financial Services Professional

CFA Level 2 Candidate