By Roger J Kerr
The market forces that will cause movement in our interest rates over the next 12 months are gathering momentum and pricing across the yield curve will start to reflect the relatively more probable scenarios going forward.
The three big interest rate influencers are the NZD exchange rate, NZ GDP growth and US long term Government bond interest rates:
1. It is well signposted that the RBNZ would prefer the NZD/USD exchange rate to be in the mid 0.7000’s before they commence increasing the OCR from 2.50% come next March.
Governor Wheeler knows that mortgage interest rates in New Zealand are currently too low given the residential property market price pressures and thus ultimate inflation pressures.
He also knows that shunting short-term interest rates upward when the NZD/USD exchange rate is already above 0.8000 will push the currency even higher and damage the economy as exporters become unprofitable and do not invest. He does not want to be responsible for that outcome.
He has to pin his hopes on the fact the global FX markets will drive the US dollar stronger against all currencies and provide the lower NZD/USD window he needs.
Recent developments in international currency markets will provide the good Governor with some hope in this respect.
2. The upward momentum in the NZ economy is unmistakable with last week’s employment figures confirming what consumer and business confidence survey have already been telling us.
Confidence in the dominating rural sector is the highest it has been for five years as higher prices and production increase incomes.
Rising inflation always follows strong GDP growth, particularly if the NZD/USD exchange rate comes off somewhat.
Inflation rates in New Zealand do not stay at 1% for long when the economy is expanding at 4%.
3. The correction downwards in US 10-year Treasury Bond yields from 3% to 2.5% through the US monetary and fiscal uncertainties over September and October is well and truly over.
A much stronger than expected Non-farm Payroll employment result for the month of October has reversed the bond yield upward to 2.75%.
New Zealand term swap interest rates did not correct down as far as the US bond yields, however they have followed the US interest rates upwards (as they always do!).
What all this means for borrowers and investors at risk to market interest rate movements is that short-term (90 day) interest rates will be at least 1% higher in 12 months time and three to 10 year swap rates will up to 1% higher as well.
The increase in our interest rates has been a long time coming and much delayed due to earthquakes and a weak US dollar exchange rate.
However, right now the all the forward indicators are unanimous in their signaling of what is to come.
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Roger J Kerr is a partner at PwC. 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
12 Comments
The property market is not being driven by hyper domestic buyers.
Interest rates in NZ are currently very high - on a global relativity scale.
The RBNZ does not have a mandate to raise interest rates because of house prices - they follow CPI & inflation and adjust accordingly. House prices are not aprt of the CPI or inlfation figures.
Actually, we will be looking at cuts not hikes. Look at the ECB - emergency cuts. The local domestic economy, small business & household is still very fragile.
Westpac cuts 2 year rate http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11155257
Chairman. - you're not suggesting that banks dictate where interest rates head. They may play with their margins a little as ASB and WEstpac are currently to tweak their market shares, but in the end the Central Bank dictates where short term rates go (and floating mortgage rates with them) and the market dictates where long term rates go (and fixed mortgage rates with them).... That said the inflation monitoring performance, of lack of it, by a central bank will add to the direction that the market takes long term rates.
Central banks do not get driven by where inflation has been, or indeed where it is currently, as monetary policy only affects the economy and inflation 12-18 months out. It has forecasting models for that which have correctly indicated a benign inflation outlook through the past 5 yrs of the GFC, but that has now changed...they have clearly signalled the bottom and the need to move early next year to maintain their cap on inflation which is their mandate. Those that think that, one, banks controls interest rates, and two, that the current inflation level has any material influence on the central bank, is setting themselves up for an education over the next couple of years barring a global shock.
Roger is correct
Grant,
The banks may not materially affect interest rates; but they do apparently considerably affect velocity of money and capital flows in and out of the country. Roger has pleasingly bought into the notion that the Reserve Bank is very focussed on the exchange rate; and not just for its inflation effect. (I don't recall Roger showing much concern in the current account space in the past). Assuming Mr Wheeler is indeed concerned about the trading effects of the exchange rate, then he will continue the pressure on the banks to slow lending growth, and so slow capital flows in; without otherwise affecting interest rates more or less than he would for his inflation objectives.
Home lending falls as new rules bite. It seems lending growth has slowed, at least for a week, so maybe the effects are being felt. If that effect should nudge the exchange rate down a few points, then win win; and then (and possibly only then) interest rates can go up.
Stephen - yes agreed, banks do affect the velocity of money and fortunately they have kept lending through the GFC whereas others didn't and so I guess if it was measured properly, it would be down but not greatly in comparison to those countries where credit collapsed..US & Europe in particular. And yes, the RBNZ is and will slow the banks lending further here but that's a known by markets and forecasters and priced into the April OCR hike expectation ..but that aspect of LVRs and other changes they could bring in before Christmas are certainly the main question marks over the timing of hikes.
MortgageBelt - I only talked of inflation forecasts, which if you understood interest rates you'd appreciate is important. Just about every line of your response is incorrect and I will not debate with you as past performance suggests to me I'll only have the same extreme frustrations in doing so...good luck with how you handle your interest rate risk.
So the last 4 years, OCR has been cut.
But floating rates have remained the same (& not cut).
Banks are building their 'disconnect' theory atm. They raise & cut independantly increasingly.
The forecasting models have been wrong for 5 years.
Trading banks still prefer fluctuating and rising rates. They can exploit the borrower easier. And exploit their wholesale market advantages that the retail borrower is locked out of.
More than 2 years I think....and yes its hard to believe when you see the continued strife in the EU, Japan and the USA that 4% sustained (ie trend) growth is possible in NZ. Roger isnt alone of course, many of his outlook seem to have similar views.
It strikes me that there is a continuing and increasing gap between main street where I am and wall street (finance land) and the ppl such as Roger who live there. What I see is the top ppl are bidding up commodities, shares, expensive housing, assets and thinking all is well etc yet real goods and jobs (and wages) are no where.
So really yes we'll see some inflation in areas that demand monopolistic rents. These however will make things harder for main street and not easier, so rising the OCR will be a double whammy IMHO.
regards
Inflation rates in New Zealand do not stay at 1% for long when the economy is expanding at 4%.
I'm not following you Roger? 4% GDP growth? I hope you're correct, but I'm not sure where this figure has materialised from.
The increase in our interest rates has been a long time coming and much delayed due to earthquakes and a weak US dollar exchange rate.
Perhaps you could comment specifically to what's really the cause of our high $NZ?
Not much delayed due to other factors?
Like, expensive energy, debt overhang, 5~6 years of at best stagnation globally if not recession. Massive un-employment in the EU especially the youth.
For the last 5~6 years we have seen such predictions, yet if anything globally its looking worse than its ever been in that time.
So 1% sustained seems a bold prediction, especially as energy is so "cheap" due to the continued recession. Wait til we do pick up and energy demand and hence prices rises again, squashing that. Of course a stuck clock will eventually tell the right time, if only briefly.
regards
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