Opinion: How economy recovers will determine interest rate bottom

Given the global banking/financial market meltdowns that are occurring with regular monotony, the big question for corporate borrowers and fixed interest investors is "“ How far will interest rate fall to on this down-cycle? One has to subscribe to the view that the RBNZ may now see "neutral" settings for monetary policy as a 6.00% OCR, not the previous 6.50%, because the bank credit crunch has added further to the banks' cost of funds, thus borrower's all-up interest costs. The probability of interest rates going below 6.00% will increase if the global economic downturn gets worse in 2009 and our agricultural export commodity prices fall. This will reduce the chance of an export led recovery in the economy through 2009. The current monetary easing process is all about re-balancing the economy away from domestic spending to export incomes and performance. It will take some years before household balance sheets are de-leveraged back into shape, therefore all the arguments about mortgage rates are superfluous in my view. The level of mortgage lending rates is not a key driver for the economy, export growth and incomes are. Therefore, the four main banks seem happy to keep their lending rates substantially higher than the smaller competitors. They do not care if they loose new business to Kiwibank, as the big boys are not about growing their assets anymore. They are concentrating on liquidity, thus they will be happy if some of their borrowers refinance elsewhere. Other lenders are increasing their rates to encourage clients to refinance and repay. I remain optimistic that our food-based commodity prices will not decrease over the next 12 months as much as mining and metal commodity prices. Therefore the global economy can slow to weaker growth, but we could do OK with a lower NZ currency value and our export prices holding up. However, do not expect the export-led economic recovery in 2009 to be smooth or easy. My point is that there is still a very good chance of 1 % to 2% positive GDP growth for calendar 2009 and into 2010 which should halt the RBNZ at 6.00% in the OCR. The media may portray the banking collapses and rescue packages as the "end of the world as we know it" "“ it's serious stuff, but in reality it is perhaps just returning the cost and availability of credit to where it should be. The period 2001 to 2007 was the anomaly with unsustainably low credit margins and excessive liquidity. This may appear to be a black hole, but it is really just one large hangover after a party that went on too hard for too long! ------------------ *Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com.