The only way is up (for interest rates)

Bonds / opinion

The Reserve Bank has provided the 'Go' signal for financial markets to start pushing up interest rates and the Kiwi dollar

27th May 21, 2:47pm by David Hargreaves

This week's Monetary Policy Statement from the Reserve Bank felt in many ways like a return to the 'old' days when our central bank got the financial markets to do its bidding with discreetly raised eyebrows and surreptitious taps to the nose.

I had been wondering how the RBNZ was going to cross the divide between what it had been saying about needing to keep very stimulatory conditions - and the dawning reality of a Kiwi economy that has been wholly more resilient than the most optimistic of optimists might have picked.

In the event, the RBNZ didn't really cross the divide at all. We had a Monetary Policy Statement delivered with pretty much all the same cautionary messages. Move on. Nothing to see here.

Look in the back of the document (page 42), however, and there's the gunpowder. Just some numbers. But powerful ones. Under the 'OCR' heading. And showing that whatever the RBNZ might be saying in the front of the document, it is believing it will need an Official Cash Rate of 1.75% by the middle of 2024. (The Monetary Policy Statement is here.)

Or, more to the point, it's telling the market, that's what it believes.

Go for it

Effectively it handed the ball to the market and said: "Here, run with this." And the market didn't need any further cues, quickly pushing up wholesale interest rates and the value of the Kiwi dollar. The MPS might have run to 50 pages of text and graphs, but it was those few numbers on page 42 that were the beginning and ending of it all.

Without the RBNZ really saying anything untoward, those OCR numbers have created an expectation in the marketplace that things are now going to be moving up.

Before the OCR was introduced some 22 years ago now, the RBNZ needed to, in effect 'guide' the market with that raised eyebrow language referred to earlier. If it wanted interest rates higher it had to indicate that, if it wanted them lower, it had to indicate that.

By using the OCR 'forward track' in the MPS the way it has this week, the RBNZ has very much returned to that more subtle style of operating. I think it will have been delighted with the response from the market to the MPS this week. It hasn't said it is going to start tightening monetary policy. It didn't need to say it.

The market will now run with it. It has free licence. It will now do the RBNZ's work for it, without the central bank having to say or do anything for now. Observe that while the RBNZ has projected a first OCR hike in the second half of 2022, the market has already now decided it will be in May next year.

'Hiking expectations'

As ANZ chief economist Sharon Zollner and senior strategist David Croy observed, I think very nicely, in their review of the MPS: "The market is likely to extrapolate the recent pattern of revisions, testing bringing forward hiking expectations on every strong piece of data over coming months."

Dead right, I think. So, yes, any positive 'shocks' with economic data in coming months will be met with expectations of those OCR hikes being brought forward. So, wholesale interest rates will keep rising and so, likely, will the Kiwi dollar.

How much of this upward pressure might find its way into retail interest rates then?

I think for sure that some upward pressure will find its way into the bank rates you and I are offered - and probably sooner rather than later.

That means you can probably expect to see some term deposit rates (probably the longer dated ones) starting to creep up.

And mortgages?

Well, that will be the interesting one.

Rate rises

But I reckon if wholesale rates keep pushing up then we will see that too - particularly again I might suspect with the longer term fixed rates.

The rises won't be huge, not till we see an OCR rise, but they will be symbolic enough. Rates are on their way up.

How high or fast might rates rise though?

I think most people would have been very surprised at the magnitude of OCR rises suggested by the RBNZ projections.

I was astonished.

The worrying thing from my perspective is that these projections are based on the central bank's view that the current inflationary pressures we are seeing will abate by the end of this year.

There's this key qualifier from the RBNZ in the MPS document:

The current pressure on supply chains is assumed to result in a temporary change in prices that at least partially reverses as conditions normalise. However, there is some risk that the change in prices is more persistent and leads to ongoing inflationary pressure. Consistent with the Remit, the MPC would be expected to respond to ongoing inflationary pressure if it were perceived as being inconsistent with the inflation target.

Okay, so in other words the RBNZ reckons an OCR of 1.75% will be necessary by the middle of 2024 if inflation subsides.

So, in other words that OCR track from the RBNZ is actually something of a 'best case scenario'. As long as inflation behaves the OCR will ONLY need to be 1.75% by mid-2024!

But what if inflation doesn't behave? I'm certainly not convinced that the global inflation pressures we are seeing at the moment will be temporary.

Mortgage shock

If they ain't then the supposition is that an OCR of rather higher than 1.75% would be needed by mid-2024. And that could be a shock.

Now, just start thinking about that in terms of some of the whacking great mortgages that people have been signing up for recently.

I recently had a play around with interest.co.nz's mortgage calculator and the results didn't look too flash in terms of what a difference relatively small increases in mortgage rates will make.

So, it's game on, people.

The financial markets are on notice. They will now do the RBNZ's bidding.

The only way is up. Strap yourselves in.

We welcome your comments below. If you are not already registered, please register to comment

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

53 Comments

by CWBW | 27th May 21, 3:05pm 1622084731

The assumption of rising rates depends on nothing negative happens in the next 18 months in the global economy. Unless the USD strengthen quite a bit relatively, pushing the NZD up is not conducive to a recovering economy.

Based on this, I think the odds are 50/50, with the downside much greater than the upside. The risk is asymmetrical.

by Tom Valen | 27th May 21, 3:22pm 1622085721

Like Punxsutawney Phil, I expect Orr will be running for his hole at the first sign of his shadow.....so lord knows what he'll do if someone quietly mutters under their breath about house prices falling by a few percent, or if some weak GDP numbers were to eventuate. Getting a rate rise out of this guy will be harder than going to the moon on your bicycle.

by stuart786786 | 27th May 21, 3:49pm 1622087387

'The assumption of rising rates depends on nothing negative happens in the next 18 months in the global economy.'

Reserve bank action should be based on the economy but here is based on mood of the people in the board, headed by Mr Orr, so CWBW if at that time mood is not to raise interest, believe me Mr Orr and his gang will find a reason not to raise or otherwise depending upon the mood will find reasonto raise.

by JimboJones | 28th May 21, 1:50pm 1622166603

"Reserve bank action should be based on the economy" - no just inflation and bank stability. I am sure if inflation beds in Orr will raise rates, his job is fairly black and white and he is doing it correctly.

by Independent_Observer | 27th May 21, 5:00pm 1622091610

Haha I love how simply you view the world.

By ‘nothing negative’ I assume you mean something that might be deflationary as opposed to what might be very inflationary which could see interest rates rise? High inflation is also a negative. So if we get deflation now and falling wages that is bad, but if we get inflation and rising interest rates that is also bad.

A lot of guys who picked the events around the GFC think the Fed are cooked and see extremely high inflation coming up but they can’t do anything about it! Raise rates and the economy gets decimated, don’t raise rates and risk hyperinflation.

by Balanced Life | 28th May 21, 9:26am 1622150803

Well said.

by JimboJones | 28th May 21, 1:56pm 1622166991

I think they would raise rates if they did think excessive inflation is coming. It is obviously a risk but I doubt the Fed or RBNZ think it is a very high risk at the moment.
Not sure about the Fed, but the RBNZ is only really concerned with inflation and bank stability, the state of the economy is not it's problem. They will raise rates if they need to.

by linklater01 | 28th May 21, 2:44pm 1622169868

I_O,

My crystal ball is just as cloudy as everybody else's, but for what it's worth, I think we will see a significant rise in CPI inflation-we already have it in asset price inflation-and a consequent rise in the OCR. If it went to 1.75%, that would represent 6 hikes of 0.25% over say 18 months from mid 2022. Will that happen? only if other CBs play along otherwise our $ could rise sharply, putting a lot of pressure on our exporters.

Further out, I think that the pressures which have acted to reduce CPI inflation will prevail. I also believe that global GDP will contine to fall, partly due to a continuing decline in the EROI of oil.

by Averageman | 28th May 21, 7:37am 1622144259

Strap yourself in indeed. What if inflation is higher than expected and the increase needs to be higher.

by saamee | 27th May 21, 3:12pm 1622085159

Real Estate carnage will be coming next year and onwards.

Even is Mike Hosking cannot see it yet!!!

by Palmtree08 | 28th May 21, 7:22pm 1622186568

Bite your tongue! Carnage is impossible without Mike's prior approval!

by Tom Valen | 27th May 21, 3:17pm 1622085450

Should I strap myself in for something that may or may not happen in September next year?
We've had Mr Orr tell us that inflationary pressures will abate and dissipate like mist on a warm spring morning, so is that indicative of some chunky rate rises at some time in the future?
I'm hardly going to work myself into a frenzy over a snail making it's way across my back lawn, and that is the same pace that this will move at, so I don't understand the frenetic 'go, go, go!!' commentary.
We have been very poorly served by 'useful idiot' economists who holler from the rooftops for rate cuts at the first sign of GDP growth slowing down, yet during our 'rockstar economy' interest rates went nowhere and they didn't make a peep about it. That is why we are in our current mess with the credit spigot still turned on full bore despite whatever jawboning Mr Orr may come out with.

by Millennial_Woman | 27th May 21, 3:46pm 1622087172

This is worth repeating

"I recently had a play around with interest.co.nz's mortgage calculator and the results didn't look too flash in terms of what a difference relatively small increases in mortgage rates will make.

So, it's game on, people."

by stuart786786 | 27th May 21, 3:56pm 1622087799

Even if interest rate does rise will be very slow -, yet will never see go high for next five to seven years for sure.

by Lord Dowding | 27th May 21, 6:02pm 1622095320

Purely Jawboning the market as they a worried it will take off again in spring.

Rates might tick up incrementally but they will settle at a much lower long term average.

Prices aren't going anywhere and all the envious renting scavengers hoping for the apocalypse will still be on here in a few years time complaining they can’t afford a house having vapourised another 3 years worth of rent

by Independent_Observer | 27th May 21, 6:49pm 1622098163

Do you control interest rates and the housing market?

by status quo | 27th May 21, 7:33pm 1622100822

Seriously dude. How do you put up with your tireless negativity.

by Millennial_Woman | 28th May 21, 6:19pm 1622182783

"envious renting scavengers", "maggots"... Wow, thanks! I'll withhold my thoughts about you ;)

by theglc | 28th May 21, 4:11pm 1622175110

the mortgage lending is stress tested at 5 and 6% so even a 3% rise in interest rates wont put borrowers into the mire. But what it will mean is less money for discretionary spending which of course has an effect on retail and services industries

by iconoclast | 27th May 21, 3:59pm 1622087951

Remember Orr was appointed by Robertson
Why on earth Orr gave up an NZD $1.2 million job at NZ Super to take on a $700k pa job seemed odd
Orr is a purist while Robertson is not
They are at loggerheads over events of the past 24 months
Personally I will be surprised if Orr gets a second 5 year term

by Nzdan | 27th May 21, 4:11pm 1622088672

Maybe he wanted greater returns on his property portfolio?

by Tom Valen | 27th May 21, 4:14pm 1622088874

Wow, $700,000 dollars to be a fence-sitting figurehead who can't step outside the tight constraints The Fed have saddled him with.
I think a lame duck has more going for him than Orr, yet economists and the financial media venerate the guy as if he was Master Yoda.

by JimboJones | 28th May 21, 2:03pm 1622167402

Here we are with an economy firing so much better than anyone ever expected after Covid and you think he is a lame duck? I think he deserves a raise after all the crap that has come his way, I'm not convinced he has done anything incorrect at all.

by Narrabeen Boy | 27th May 21, 4:11pm 1622088680

Hopefully everyone with a mortgage paid off heaps of debt during the good times!!!!

by Dgm | 27th May 21, 4:20pm 1622089209

All good things have to come to an end

by rastus1 | 27th May 21, 4:31pm 1622089880

ummm nope. Mortgage debt has been surging.

by Nzdan | 27th May 21, 5:30pm 1622093442

Started off with a 25 year loan payment schedule in 2017. Refinancing in a month's time on an 8 year schedule. Easy to do when our DTI is 1.5, but making the most of the good times.

by rastus1 | 27th May 21, 4:30pm 1622089826

Property has been rising based on forever lowering interest rates. Without this 'push' one might expect declines as the holding costs will be increasing regardless and the ability to put up rents will be non existent.

What will be interesting to see is whether or not a run to the exits to lock in any gains might commence?

by brisket | 27th May 21, 4:46pm 1622090772

I'll believe it when I see it. There will always be a reason not to raise interest rates. Why would you, when they have (we are assured) such magic stimulatory power? It would take enormous and prolonged inflationary pressure to make them *actually* do it, instead of talking vaguely about possible actions years from now.

by Avocado | 27th May 21, 4:58pm 1622091514

Yup i agree, rates arnt going anywhere. This inflation blip will roll past and there will still be 10 million people unemployed in the US. The world will still be up to its balls in debt and the amount of people retiring and not spending is only increasing by the day. Massive long term deflationary pressures will always win.

by MLSmith1 | 29th May 21, 10:16pm 1622283409

But what happens when input costs remain high... and those high asset prices, reduction in net cashflow must require increased revenue to support value.
I guess we will see how far monetary policy can go vs real economy

by Independent_Observer | 27th May 21, 5:03pm 1622091819

Anyone buying more gold miners (GDX) based on this outlook?

by Becnz | 27th May 21, 9:00pm 1622106022

I am on fence done very well last year but will see if markets hold next 3 months max as so much leverage in markets that we may see gold on sale just like last year but if it breaks 2000usd I will have to topup somemore as we may not see the drop I am waiting for.
I did not buy GDX but smaller ASX explorers all tripled or more last year at some stage but have pulled back again to very attractive levels.

by Ezy | 27th May 21, 10:28pm 1622111314

How can you buy gold and sleep at night considering it's huge carbon footprint? Pulling out a very small amount from the ground has a ridiculous energy cost.

by theglc | 28th May 21, 4:46pm 1622177165

because its a one off footprint that lasts forever. that is one thing PMs have over every other asset class, no maintenance, no corrosion.

I have some gold coins from the 19th century, still as good as the day they were minted.

by Ezy | 29th May 21, 8:55am 1622235309

What about the energy cost to store and secure it? Any meaningful amount of gold literally weighs a tonne (61m USD / 1000kg currently). You need dozens of gas guzzling armored trucks for transport. Expensive vaults that are massive carbon sinks. Admin requires digital servers running 24/7 storing the ledgers. And bank staff to maintain and monitor the whole shebang. You're dreaming, gold is not a zero sum game once it's mined.

by Millennial_Woman | 28th May 21, 1:40pm 1622166036

Yep I brought GOLD etf just a couple of weeks ago

by mikekirk29 | 27th May 21, 5:13pm 1622092419

All those crowing that market can never go down etc have nothing to say now that bell is rolling on end of pressie giving by CB.

by Caughtinthemiddle | 27th May 21, 6:44pm 1622097872

The reality of the “forecasted” rises into 2024 is that these are still low compared to rates over the last decade or so. Personally I view bank rates on my debt being pretty neutral at around 4%. Less than this is definitely smile territory and above a scowl starts to appear. I’m pretty comfortable with the next couple of years and view these rates as very attractive.

by Dave Moderato | 27th May 21, 7:31pm 1622100700

This can only happen in conjunction with a worldwide economic recovery. Which is likely to be years away. Regardless of how much spin the RBNZ issues.

by Becnz | 27th May 21, 8:52pm 1622105525

I am sure we will have another black swan event to carry on this game if not good luck anyone with a large level of debt.

by ham n eggs | 27th May 21, 9:44pm 1622108643

Yip
Rate rises coming....
Any day now.....

by dago | 28th May 21, 2:42am 1622126522

RB has effectively come out and said most people should not longer buy houses. Only a select few who don't need to get into big debt should buy from hereon in. Most people on average to good incomes even with a good deposit would get into a lot of debt to buy a a house at this point, which is a big no no. Houses are only for rich people now. At what point RB believes average every day working people can buy a house again is unclear. When rates have finally risen enough to crash houses? Potentially years from now, if ever. Taking things to their logical conclusion, it would take a crash big enough to correct years worth of house ponzi madness to make housing OK to buy for average to good incomes

by ACB | 28th May 21, 8:24am 1622147084

Don't forget that the central banks want inflation and are willing to tolerate an undetermined period of above target inflation as catch-up for prior undershooting and in pursuit of full employment. This means that financial repression is a likely outcome i.e. higher inflation but still negative or low real rates. And now that gearing is so high, the ability for rates to go back to anywhere close to pre GFC days is probably impossible anyway.

by Halfway To Paradise | 29th May 21, 11:37am 1622245061

My prediction is that the target range for inflation will be increased from 1-3% to 2-4%.

by Steptoe | 28th May 21, 8:39am 1622147950

We are seeing all the comments predictions around interest rates returning slowly to historical levels.
Pre low rates the ave around the 7% to 8% over the last 50yrs +
Some much is said about those with huge mortgagees, and may not have taken into account very long term historic rates.
Yet nothing about the huge numbers of ppl who have paid off, or nearly paid off mortgages, have a term deposit that has come due, and simply havnt re invested... its sitting in their current or savings account as the difference of a term investment has little advantage.
This, going on a previous article a few weeks back, is a huge pool of money that many retired mainly ppl will looking to for better returns over and above their super.
Has anyone actually considered this large pool of cash and the influence it may have as interest rates return to normal levels?

by StuckAtHome | 28th May 21, 9:27am 1622150845

I think what many people are missing is the impact that rate rises will have on discretionary income, and hence the economy, and hence inflation.

There's just too much debt in the system now for any material increase in interest rates to be sustained without crashing everything.

by fortunr | 28th May 21, 9:32am 1622151155

Game on. Once the border reopens to international tourism, and considering the commodity prices upswings and the signals coming from many economies overseas, the risks are all on the upside.
I will be surprised if the OCR only rises as highlighted by the RBNZ: it is likely that rates will increase at a significantly faster pace than many think. Actually, Orr has only two options: start raising rates now, or wait next year until it is too late, and be forced to go for a much steeper progression.
It will be very interesting to see what happens to the NZ housing Ponzi as a result of all of this.

by mikekirk29 | 28th May 21, 10:37am 1622155068

problem with economics and its prophets is that it is all based on models and perfect market hypothesis and associated bilge. Reality, in shape of consumer preference and money and credit, is left out of the model. Everything is fine with leverage and credit.... until its not. The powers that be have decided they can postpone economic cycle and stop recessions. And that inflation is dead. Everything has a cycle and this one is back to the 1970s playbook

by K.W. | 28th May 21, 11:28am 1622158084

Whats going to happen to the rental market if mortgage interest rates double? Now that interest costs are no longer tax deductible, the number of landlords who will be in a cashflow negative situation is going to skyrocket. As will rents. Investment properties will be the first to be sold as people direct their cash to their own home mortgage, tenants will be tipped onto the streets in droves.

by brisket | 28th May 21, 3:13pm 1622171615

(dpost)

by brisket | 28th May 21, 3:13pm 1622171590

Nah, it'll all be kept afloat, by hook or by crook. Property values will go sideways for 20 years but no one will be allowed to lose their shirts. Japan led the way, then the EU... Now it's our turn. Low interest rates and zero growth 4eva.
The only thing I can see preventing that would be if eg. the US was offering higher risk-free returns than 0%, but without their currency depreciating accordingly... if you could park money somewhere at 4/5% without it losing value, a lot of low-yield property investors could pull out. Like the Japanese savers who spent decades buying NZ bonds because a few % seemed so generous... We are becoming those Japanese savers.

by mfd | 28th May 21, 3:47pm 1622173651

It'd be terrible if rents went up by as much as they fell when interest rates dropped.