By Bernard Hickey
The Reserve Bank of New Zealand held the Official Cash Rate (OCR) at 3.5% as expected, but surprised financial markets by openly talking about the possibility of a rate cut this year and dropping its previous bias towards a rate hike.
The bank referred to the slump in petrol prices and weak local inflation in commenting about the chance of deflation later this year. Wholesale interest rates and the New Zealand dollar fell sharply after the statement.
The central bank said it expected to keep the OCR on hold for some time, but pointed out future interest rate adjustments "up or down" would depend on economic data. This is the first time the bank has even mentioned the possibility of a cut.
Financial markets immediately priced in the expectation of a 25 basis point rate cut later this year. Bank economists now expect the bank to hold the OCR until well into 2016 and also now see a chance of a cut later this year. Inflation all around the world is falling because of lower oil prices, ageing populations and new technology that helps companies reduce costs and wage growth.
Governor Graeme Wheeler noted the Auckland housing market was picking up again, but made no further comment on what he would do about it. For more detail on the OCR decision and the reaction see here.
Some economists are calling for the bank to introduce new Macro-Prudential controls, similar to the high LVR speed limit introduced in 2013, which helped slow the Auckland housing market for almost a year.
What does this mean for rates?
Longer term mortgage rates have been falling in recent months as inflation remains dead globally and New Zealand's inflation is subdued despite solid GDP growth.
Money printing in Europe and Japan is also depressing long term interest rates globally, which is making it easier for banks to cut fixed mortgage rates.
Advertised floating mortgage rates are flat at 6.75% and could stay there well into 2016, unless the Reserve Bank cuts the OCR, which would be passed on. See all mortgage rates here.
Banks have been cutting their fixed rates towards 5%. Bank funding costs from overseas borrowing and local term deposits have been falling, which means banks are competing hard.
Fixed rates depend more on wholesale interest rate moves than the OCR. They also depend on the banks' funding costs on international markets, which have been falling in recent months because of deflation fears and renewed central bank money printing.
The fixed vs floating decision depends on your outlook for the OCR and your personal situation. A flat to falling OCR makes floating more attractive, while a fast-rising OCR makes fixing more attractive.
In my view, the OCR is likely to remain unchanged, possibly well into 2016, although the chances of a cut are rising.
This had made me less keen to fix for a longer than a year, but recent moves in two and three year fixed rates to well below floating rates have made them more attractive.
What does all this mean for the property market?
The property market is warming up again, particularly in Auckland as fixed mortgage rates fall, net migration rises and new housing supply remains below population growth. House price inflation is picking up elsewhere too, but to a lesser extent.
The Reserve Bank's response will be interesting. Some economists are calling for more macro-prudential measures. See more here from Gareth Vaughan on the Reserve Bank's decision and whether it is 'pouring petrol on the fire in Auckland.'