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BNZ economists question whether the recent 'rebalancing' of our economy has been enough as we prepare for the end of 'cheap money'
The expected rise in interest rates next year could give New Zealand a "bumpy ride", BNZ senior economist Craig Ebert says.
In this week's issue of BNZ's 'Strategist" publication, Ebert has taken a detailed look at the consequences of "when the cheap money ends".
The Reserve Bank has already signposted a fairly aggressive raising of official interest rates next year in response to anticipated rising inflationary pressures.
And in an article published this week RBNZ Governor Graeme Wheeler made explicit reference to interest rates needing to go higher still if the just-introduced "speed limits" on high loan-to-value lending don't dampen house price inflation, which has been running particularly hot in Auckland.
The end of 'cheap money'
Ebert therefore posed the question of how prepared the New Zealand economy is for the ending of cheap money?
"In theory, it should be good and ready," he said.
Businesses and households had years to sort their balance sheets and cash flow, following the excesses that built up over 2003-07 and the 2008/09 recession. Economic confidence is riding high, he said.
"The reality is, however, that it’s only when the cheap money is actually withdrawn that the true health of an economy, and its financial system, is revealed. In some ways, then, the true test is yet to come."
One of the first
New Zealand, Ebert said, looks likely to be one of the first (developed countries at least) to probe the path back to normal, with Official Cash Rate increases beginning next year.
"We suspect it will be a bumpy ride. But trying to avoid it might only make it a much more painful exercise later down the track."
Ebert said there had been reasonable evidence of "rebalancing" over recent years in New Zealand, with private sector debt ratios falling, household savings rates "substantially recovered" and the current account deficit shrinking.
"However, has the economy’s rebalancing been enough? We’re not entirely convinced that it has.
Not supremely confident
"Running what we’d call 'normal' interest rates through everything doesn’t leave us feeling supremely confident. But failing to do this only increases the chances of it being a much more painful exercise later down the track."
Ebert said households had gone through "deleveraging" in recent years, but despite that, household debt as a proportion of disposable income reversed only a fraction of the increase it registered over the period of upswing, 2003-07.
"And, over the last 18 months or so, household total 'household' debt to disposable income credit growth has rebounded (to a most recent 5.5% annual pace) – to the point of pushing the debt ratios back up."
Ebert said this move had coincided with renewed house price inflation.
Are house price rises justifiable?
"However, the salient question is how well founded has the recent surge in house prices been? It certainly hasn’t been justified by the economic fundamentals that it tends to follow over long stretches – such as incomes, rents, and construction costs. On this basis, the RBNZ has every reason to point out that NZ house prices are clearly over-valued. The Governor is right to worry about the end-game on this."
Ebert said that returning interest rates back to "average" would increase debt servicing costs, giving households a better sense of the relatively high debt loads they continue to carry, overall.
While debt servicing costs have dropped noticeably from their heights of 2007/08 they are still not low by historical standards, even though current interest rates are, he said.
"So a return of rates to back to normal will definitely put the squeeze on."
The potential of this squeeze was reinforced by the fact that households were still predominantly on floating or very short term mortgages.
There had been shifting into longer-term fixed mortgages over the last six to 12 months, but "nothing material". with 93% of registered bank mortgages as at August on a duration of less than two years and around half of this on straight floating.
"This suggests a lot of pinch when OCR increases come into play – especially with longer-term mortgage rates already a good chunk higher than short-term ones, giving people 'nowhere to run'," Ebert said.
He said it was worth recalling some recent international examples of economies and financial systems that became complacent during times of easy money, only to feel the backlash when rates had to rise.
"For instance, the way:
- Large tracts of Asia became dependent on cheap (and abundant) money in the 1990s as they “imported” relatively low US interest rates, in effect, by way of their exchange rates fixings to the US dollar
- Peripheral Europe – private and public – gorged on overly cheap money upon being admitted to the Eurozone tent. What was good for Germany was not good for Greece
- Many Americans leveraged into mortgages with extremely cheap short-term rates, underwritten by Greenspan’s 1.0% cash rate and slow reversal
"In these cases (and many more besides) it was only when rates were forced to return to appropriate levels – typically based on broader economic considerations – that the excesses were finally called to account," Ebert said.
"Of course, the world has needed extremely easy monetary policy over recent times – but partly because of the over-easy policy over the prior cycle. Likewise, it’s fair to say that money needs to be cheap for as long as it takes.
"There are risks in withdrawing stimulus too soon. We get that. But it’s also true that central banks have a habit of giving too much for too long. This can engender complacency and false reprieve amongst businesses, households, banks and financial markets, to the point of perpetuating a problem, not being any solution."