Economy just too strong to allow interest rate cuts

Roger J Kerr sees the RBNZ holding rates and other policy settings at current levels for for good reasons; sees hikes coming when the US Fed moves

8th Dec 14, 2:00pm by Roger J Kerr

By Roger J Kerr

Reviewing the media commentary on the NZ economy and interest rates over the last few weeks while I have been out of the country leaves one a little dumbfounded.

That is, a lot of ill-conceived wishful thinking from the normal suspects around the need for interest rate cuts because the rest of the world is doing just that.

Interest rate cuts by the RBNZ are not going to happen, just like the canning of the LVR’s did not happen last month when the mainstream media convinced itself it was a done deal.

If GDP growth was collapsing and the economy was headed for recession I could see the need for interest rate reductions.

However, this is the New Zealand economy not the Russian one we are examining.

RBNZ Governor Graeme Wheeler left the LVR restrictions in place for a very good reason; it is going to take another 12 to 24 months for the supply response to catch up to the demand in the housing market.

The RBNZ themselves will be somewhat nervous about the new inflation forecast they will produce this Thursday in the Monetary Policy Statement as the accuracy track-record of their inflation forecast model has been abysmal of late and has required a major overhaul.

It is hard to see the RBNZ forecasting completely stable annual inflation at 1% over the next 12 to 18 months as the short-term interest rate market is currently pricing.

While the dairy industry income is well down on the boomer year last year, the economic outlook still appears very robust with manufacturing, construction and meat industries all very positive and expanding.

The elongated period of share price appreciation on the NZX tells you that investors/shareholders have considerable confidence about the macro-economic environment remaining strong in New Zealand over 2015.

Anecdotal evidence from many of our clients around New Zealand (mostly manufacturing exporters) is that they cannot find the skilled and semi-skilled labour to fill the job vacancies they have available.

The reality is that these companies will be forced to lift the wages and salary levels to ensure they have the workforce to deliver the production output they are committed to.

While there is little evidence of labour costs increasing in the official statistics to date, the RBNZ’s job is to look forward at future inflation and some wage-push price increases seem to be on the way.

Governor Wheeler’s challenge for 2015 is to time our next interest rate increase to coincide with the US Federal Reserve doing the same sometime over the second half of the year. Lifting NZ interest rates ahead of the US would only push the Kiwi dollar back up and undo all the good work on that front over recent months.

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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

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25 Comments

by Stephen Hulme | 8th Dec 14, 4:22pm 1418008920

I would be great if the NZX had it's own legs and wasn't standing on the shoulders of faux giants. View NZE:NZ50C and INDEXSP:.INX - try the compare option over the 5y time frame.

To my mind, these events underline the fragility - dare I say growing fragility? - hidden beneath the markets' buoyancy. Small pieces of news can generate outsize effects. This, in turn, can amplify mood swings. And it would be imprudent to ignore that markets did not fully stabilise by themselves. Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets' buoyancy hinges on central banks' every word and deed. Read more

by MikeM | 8th Dec 14, 9:30pm 1418027400

"I would be great if the NZX had it's own legs and wasn't standing on the shoulders of faux giants. ViewNZE:NZ50C and INDEXSP:.INX - try the compare option over the 5y time frame."

Very true, Stephen.

And regarding Mr Kerr's outlook on interest rates, some have other ideas.......

http://www.bloomberg.com/news/2014-12-08/one-hundred-years-of-bond-hist…

by steven | 9th Dec 14, 10:13am 1418073180

Including myself and other "peak oilers"

The last 100 years was the age of [cheap] oil. Un-precidented expansion/improvement on all fronts, population, food, life expectancy, engineering, sciences. The next hundred years will see that oil age decline and end circa 2030~2060.

So just how interest rates can ever get to the levels seen during periods (and for the length of) on the way up mystifies me. I indeed think the new normal OCR is now 0.25%~2%.

meanwhile in la la land,

"surprising everyone on Wall Street who anticipated the central bank’s unprecedented stimulus would lead to stronger economic growth, faster inflation and ultimately higher borrowing costs."

So the self-proclaimed "masters of finance" dont have a clue, ergo why listen to them?

Going to be interesting, yes indeed.

by MortgageBelt | 8th Dec 14, 5:41pm 1418013660

Interest rate hikes in NZ are simply not going to happen.

The CPI is 1% and possibly on the decline - this would be under the RBNZ range.

The NZD is already uncomfortably high - any hike would send the NZ $ higher still.

The jury is still out as to whether the USA will hike, or ever hike again in the foreseeable future. It may like to hike but vonditions keep getting in the way.

2017, 2019 , yes we may get a small hike or two. Before that, nada.

What at is this obsession with wanting high interest rates, so we can handicap all small businesses and suppress household spending? Higher interest will not make one iota of difference to the irrational Auckland housing prices, so why not let all sectors operate without the special NZ handicap.

by muntijaqi | 9th Dec 14, 8:35am 1418067344

suppress household spending by increasing high interest rates?

Unless you mean suppress consumption based on debt, which is always bad, I don't see this suppression of household spending.

Auckland housing prices are irrational, because irrational is its market and irrational are the people who strive to take on mortgages on overpriced houses. Increasing interest rates would mean that at least we don't put the whole NZ economy at risk. If these irrational people still see as "good investment" taking on loans to buy overpriced assets and sell them to each other maybe when the cost of their loans increases they don't see it as a good investment anymore and decide to invest in real productive economy instead.

Also there is the good old fashion saving purpose. I save money and spend only what I have. Why wouldn't savers prefer high interest rates and and economy growth based on productivity rather than on credit? It's just healthier for everybody in the long term.

by moe | 9th Dec 14, 12:30pm 1418081438

I'm not at all highly-leveraged but a rise in interest rates does reduce my household spending into the local economy.

I increase my mortgage repayments at the same rate as my mortgage has increased. I maintain my level of regular savings/investment and reduce my "nice to haves" expenditure. Things like the odd coffee, lunch purchase, electronics, toys, books etc (things purchased in local stores). How does this help the economy outside of Auckland?

I'm not going start thinking about selling my house, and neither will 99% of homeowners even if they are highly leveraged and living in Auckland. They just go without other things (dental/medical visits, "nice to haves", new football boots for little Jimmy etc) which are stimulating the local economy.

So in my personal experience a rise in interest rates, results in a shift of cashflow from local entities to Australian banks.

by muntijaqi | 9th Dec 14, 12:52pm 1418082760

Once you have taken a mortgage it's obvious you prefer lower interests and inflation so you can afford bigger repayments, but for those who are not indebted like myself interest increases mean more savings, more savings mean more investment in productive economy (with real money! not with debt like the real estate "investment") and more investment in productive economy means more quality jobs and stable growth through productivity and not through debt.

It's the two points of view on the same situation, I believe the problem is not interest rates but overpriced assets, high leverage and low salaries due to low productivity. And to correct that we need to bring interest back to neutral levels (increase them) and stop putting the whole economy at risk for a few speculator's sake.

What stimulates local economy is consumption, yes, but if you get a loan to consume in your local economy that's not really helping anybody. And that's exactly what happens with low interest rates when people take on loans for overpriced assets.

by muntijaqi | 9th Dec 14, 12:54pm 1418082875

In USA in the 20s people were taking loans to invest the money in financial markets and were indeed consuming a lot in local economy with all these cheap money created out of nothing. We all know what happened.

by moe | 9th Dec 14, 1:20pm 1418084405

In similar fashion, once you don't have a mortgage, it's obvious you prefer higher rates so you can earn more on your increased savings. I'd be happy with that if I was in the same situation.

"neutral levels" are not where they used to be. Fine if NZ is consistant with the rest of the world, but that isn't the case. A high dollar, less borrowing by business, less local consumption etc will put the economy at risk.

Raising interest rates isn't effective in dropping the price of Auckland housing. It's an issue which needs to be addressed locally without dragging the rest of the country down with it.

by wtf | 8th Dec 14, 9:43pm 1418028202

People forget there is another reason central banks and trading banks raise interest rates. Panic and the need to attract capital and roll over loans in a credit crunch or sustained speculative attack on a currency. From memory Don Brash when RB governor rang Key while he was working for ML and asked him to lay off NZD for this reason. During 2008 crash the NZD was falling up to 5-10% a day at times. Carry traders dumping and running for safety.

by cowboy | 8th Dec 14, 9:52pm 1418028728

NZ economy outside the top offices and government gravy train, is really suffering!!

Fonterra is paying out under cost of production (@ rent = 4%) for many people and is looking like it's going to drop under 80% of breakeven.

Massive flow on for thousands of other average people.

So lets be truthful.... the reason there won't be interest cuts is because of what that would do for the NZ dollar... and the government wants to be able to borrow cheap, and a bunch of folks want to get foreigners buying NZD...get that "foreigner investment" rolling into the government coffers.

Any cuts would need to be targetted, and that's against government policy, because it's against policy. And it must be bad. not mention would actually require work, realy KPI's, and possibly even accountability for targets. So much easier if everyone covers their butts with the same "One Rule for rich and poor"

by Boatman | 9th Dec 14, 10:16am 1418073382

Yes , what happened to all that BS coming form the Reserve Bank about inflation risks a few months back .

We all knew it was a load of codswallop , everything was going down , clothing , processed food , fresh fruit and veg , meat , diesel and petrol , toys , sports goods , gifts , even accomodation and airfares went down.

Rents , electricity , and wages were flat . Even a visit to the barber shop did not go up this past year

Our household running costs were actually lower in 2014 than 2013 , and we saved more money in cash in the bank this year than ever before (thats ever since we got married almost a quarter of a century ago)

The only thing going up was Auckland houses , building materials and chippies wages .

Nothing has chagned

by steven | 9th Dec 14, 10:19am 1418073540

"Based on bond yields, inflation expectations over the next 30 years have fallen below 2 percent and reached a three-year low of 1.96 percent at the end of last month."

So many have been wrong for 5~6 years on inflation, but still persist on it. Strikes me as dogma and not logic. Personally when I get things wrong I look at why and try and learn from that experience. I'd suggest someone's are going to lose their shirts, the Q is indeed who, or maybe even most/all.

http://www.bloomberg.com/news/2014-12-08/one-hundred-years-of-bond-hist…

thanks MikeM interesting link.

by Stephen Hulme | 9th Dec 14, 11:16am 1418076960

Not that the market is wrong, your link seems not to work, but a quick calculation of breakeven yields from this active page confirms your assertion - nonetheless, I would advise caution and not bet the house on term rates falling.

"My generation gave former tenured economics professors discretionary authority to fabricate money and to fix interest rates.

We put the cart of asset prices before the horse of enterprise.

We entertained the fantasy that high asset prices made for prosperity, rather than the other way around.

We actually worked to foster inflation, which we called 'price stability' (this was on the eve of the hyperinflation of 2017).

We seem to have miscalculated." Read more

by MikeM | 9th Dec 14, 11:34am 1418078075

Agree. It would certainly be foolish to bet the farm on lower for longer. The bullish US employment data being a case in point.

Question is, does a robust US economy still have the grunt to supercede all the current offsets and absorb the surpluses of Germany/China/Japan?

by steven | 9th Dec 14, 11:50am 1418079000

The point is that interest rates will remain low because BAU growth is finished long term due to peak oil. So its not so much betting the farm but getting out of Dodge IMHO.

Oh and the so called robust US economy is questionable I think, and to absorb the output it needs to do so via more consumer debt, there is no other avanue for it I can see. Add in china's output (exports) hasnt really been aborbed in a decade, their GDP growth has been acheived via excessive building etc so a ponzi scheme.

by steven | 9th Dec 14, 12:03pm 1418079780

just checked it from here seems fine.

"term rates falling" There is a difference between the OCR, what a depositor gets and the retail mortage rate, I accept that. So sure the OCR could go to say 1% and I think it will, the problem for the NZ banks is they have to lend offshore and who will lend to them? and hence reatil rates may well not go lower. That doesnt mean of course that deposit rates cant go lower.

Not sure where that 2017, comes from, ah google is my friend,

http//www.zerohedge.com/news/2014-12-06/jim-grant-sums-it-all-2-stunning-para…

oh and Jim grant was one of the delusioned who thought 5 years ago hyper-inflation was coming and is still convinced he was right.

"Jim Grant Sums It All Up In 2 Stunning Paragraphs" as via CATO, right wing fruit cakes who look at "fundimentals" oh boy, what wacko jobs. I love it how the free market ie "the masters of finance" blames others ie academics for this mess.

I wonder if the lynch mobs will agree, think not and if it comes to it (and I hope not) they at least hang the right ones.

by Stephen Hulme | 9th Dec 14, 1:10pm 1418083811

That fruit cake, if you wish to label him so, cleaned up in this market as did I - like Bill Gross he does not have to pick up the phone for anyone. Don't confuse dogma with abilty to foresee outcomes that keep paying. As they say don't give up the day job.

by steven | 9th Dec 14, 3:08pm 1418090880

Yet he sees inflation and it never happened......

Dont confuse being a successful parasite with someone who makes an actual good.

by Stephen Hulme | 9th Dec 14, 3:48pm 1418093325

Money printing is solely for the parasitic, it has no other duty, and it behoves those in receipt of it's issue to act accordingly. If you think otherwise give up the mortgage.

by Roelof | 9th Dec 14, 5:16pm 1418098572

Thats very well said.Stephen. money printing really is the wolf in sheeps clothing.... and u are right... it behoves us to act accordingly.

Its a shame so few understand..... that they are being fleeced.... slowly ...over time...

I'm guessing u were a poet in a past life... as well as an interest rate trader..???

by steven | 9th Dec 14, 6:47pm 1418104020

Its a shame that actually so many dont even get past economics 101. Deflation is an even bigger loss on your property than a bit of inflation is and that is what we are playing with right now. And I mean inferno and not a camp fire.

by Stephen Hulme | 9th Dec 14, 7:36pm 1418106996

Property deflation - examples in NZ please.

Notably, the present value (PV) cost of a fixed rate periodic interest repayment term bullet mortgage is higher for a 3% mortgage than it is for one at 6%.

by steven | 9th Dec 14, 6:47pm 1418104020

Of course the Fed is QEing and not printing, and where pray is the inflation from it? and I dont mean make believe asset bubbles in property. So really the ones to make the most of the "printing" is the financial types as they pump up commodities and assets with cheap borrowed money, making poor ppl pay a lot more than they should. Kunstler has it right I think on the outcome for such ppl.

by cowboy | 10th Dec 14, 8:07am 1418152059

Do need to print to keep up with the macro-economic inputs.

As soon as we're off that track then clearly we no longer match currency tokens to scarce resources, so someone must be playing games if it's above or below that level.