By Bernard Hickey
The Reserve Bank has held the Official Cash Rate at 3% as expected.
But it has signaled in its December quarter Monetary Policy Statement (MPS) that interest rates are now expected to rise “to a more limited extent” than it projected in its September quarter MPS. The Reserve Bank said economic growth had moderated with weak business investment and household spending because many were cautious about adding more debt.
It also saw little evidence that the expected spike in headline inflation because of October’s GST hike was being passed on in into higher underlying wage and price inflation.
“While interest rates are likely to increase modestly over the next two years, for now it seems prudent to keep the OCR low until the recovery becomes more robust and underlying inflationary pressures show more obvious signs of increasing,” Reserve Bank Governor Alan Bollard said.
Back in September the Reserve Bank forecast the 90 day bank bill rate would rise from 3.3% then to 4.7% by the March quarter of 2013, including the potential for an OCR rate hike the March quarter of 2011.
Now the Reserve Bank is forecasting the 90 day bill rate will rise to a peak of 4.4% by the March quarter of 2013 with the next hike in the OCR not implied until either the June quarter or the September quarter.
Elsewhere, the Reserve Bank also signaled it wanted the government to reduce its structural deficit, arguing this would allow the Reserve Bank to run lower interest rates and would take pressure off exporters because it would allow a lower New Zealand dollar. It also estimated the Christchurch earthquake had triggered reconstruction work that would add NZ$5 billion to GDP. This would help GDP growth rebound to almost 4% by the middle of 2012 from below 2% for most of 2011.
‘House prices still over-valued’
It also forecast house prices would continue to fall through 2011 because prices remained expensive relative to incomes and rents.
“This overvaluation, along with some gradual increase in mortgage interest rates, is expected to see house prices rise only gradually beyond 2011,” it said. It forecast house prices would bottom out in late 2011 before recovering to 2009 levels by 2013.
Prices would, however remain below their late 2007 peaks.
What it means for mortgage rates
The Reserve Bank now sees short term wholesale interest rates rising only another 1% or so over the next two years, rather than the 1.2% it had been expecting in September. It is now also projecting that rates won’t start rising until after the middle of next year.
This means floating mortgage rates are now expected to rise from around 6.2% currently to around 7.2% by the end of 2012 and won’t start rising until the second half of 2011.
Fixed mortgage rates, which are currently around 6.5 to 6.6% may even fall slightly in coming weeks if the markets and banks believe the Reserve Bank’s more moderate outlook.
What I think
Anyone who arrived from Mars after a couple of years away and looked at Reserve Bank’s December quarter monetary policy statement would be scratching their heads.
How is it a Reserve Bank can virtually promise to keep the Official Cash Rate on hold at 3% for another six months when headline inflation will hit 5% next year and it is forecasting economic growth will rise to 4% within the next two years? Surely this does not compute?
An OCR lower than inflation and economic growth for a couple of years?
Surely that will just inflate yet another credit-fueled bubble? The Reserve Banks is relying on the power of households and businesses remaining reluctant to take on extra debt in the next couple of years.
The initial signs are the Reserve Bank’s confidence in the power of deleveraging to keep a lid on the economy might be justified. But I worry that the banks are trying to unleash those animal spirits in the housing markets again.
Mortgage approvals have surged again in the last four weeks and the banks are out again offering 90% plus home loans. ANZ’s new CEO David Hisco even told us this week the country’s biggest bank was “bank in the game” and loosening its credit rules a bit to increase demand for loans.
House prices are already stabilizing in the wealthier parts of the country. The Reserve Bank’s strategy has some risks attached.
What the Reserve Bank said. Here is the full release below.
The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 3.0 percent. Reserve Bank Governor Alan Bollard said: “Interest rates are now projected to rise to a more limited extent over the next two years than signalled in the September Statement.
“The pace of economic growth appears to have moderated. Corporate investment intentions are now below average. Household spending also remains weak, with household credit still flat and housing market activity slowing further. House prices may decline a little further in the near term. This continued household and business caution suggests current low interest rates are having a less stimulatory effect than in the past.
“On the positive side, activity in New Zealand’s trading partners continues to expand. Growth in the Asia-Pacific region remains strong, and growth in the US and UK has turned out a little stronger than was projected. Consistent with this, export commodity prices, which were already very high, continue to increase. While this is encouraging, downside risks to global growth and export prices persist.
“Repairs to earthquake damage in Canterbury are expected to add to GDP growth over the projection period. The earthquake appears to have caused about $5 billion of damage to infrastructure, and residential and commercial property. “While the near-term outlook for GDP growth has softened, beyond this, higher export volumes and earthquake repairs are expected to push GDP growth above that projected in the September Statement.
As growth recovers, current spare capacity will gradually be used up, causing underlying inflation to pick up. More immediately, the recent increase in the rate of GST will cause headline CPI inflation to spike higher temporarily, although there is little evidence of this spike affecting price and wage setting behaviour.
“While interest rates are likely to increase modestly over the next two years, for now it seems prudent to keep the OCR low until the recovery becomes more robust and underlying inflationary pressures show more obvious signs of increasing.
“The New Zealand dollar has appreciated significantly since the September Statement. Sustained strength in the currency is inhibiting the rebalancing of economic activity towards the tradable sector. Accelerated elimination of New Zealand’s fiscal deficit could help improve national savings, thereby easing current pressure on interest rates and the New Zealand dollar, and reducing New Zealand’s dependence on international borrowing.”
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