Kiwibank economists say there's "mounting pressure" on mortgage rates to be adjusted higher.
In their weekly First View publication the economists say wholesale interest rates have risen because market traders "have pulled forward" expectations of when the Reserve Bank will raise the Official Cash Rate.
(The OCR is currently at 0.25%, but in its May Monetary Policy Statement the RBNZ indicated it would start raising the OCR in the second half of 2022. As further context, the RBNZ has its next review of interest rates on Wednesday, July 14, while the next inflation figures are out on Friday, July 16).
"Since the RBNZ's MPS in May, short term interest rates have been catapulted higher," the Kiwibank economists say.
They say that since the release of the March quarter GDP figures, which showed a 1.6% rise in GDP and was far ahead of any market expectations, the wholesale rates have moved higher.
"Over the last few weeks, interest rates have moved beyond our 'upbeat' assessment and are factoring in a rate rise by year end!"
The say looking at short-term rates, the market pricing now suggests a basically 50% chance of a 25 basis-point hike in the OCR to 0.5% in November, while a hike is fully priced by February 2022. The Kiwibank economists are picking the first in May.
"A second hike to 0.75% is priced by August, we agree. And there's a third hike by May 2023, with another to 1.25% by the end of 2023," the economists say.
"The confidence around future rate hikes is starting to hit home. Homeowners are now fixing their mortgage rates for longer terms. And pressure is building. Given the uplift in wholesale interest rates, there's mounting pressure on mortgage rates to be adjusted higher too."
'Enormous amount of mortgage fixing flow'
They again noted the short duration of fixed mortgages currently, with 80% of the mortgage book needing to be refix in the next 6 to 12 months.
"That's an enormous amount of fixing flow into a tightening cycle. Any pullback in rates should be used as an opportunity to get set (pay fixed)," they say.
On rising prices the Kiwibank economists note the global supply-chain disruptions that have led to rising shipping costs.
"In recent years, firms such as retailers had found it difficult to pass on rising costs to customers for fear of losing market share - or sales to digital competitors such as Amazon or Alibaba. But the fallout from covid is being universally experienced, so costs will likely be more easily passed on. Cost push inflation is typically looked through by the RBNZ and is usually temporary in nature. However, the current experience looks likely to be more sustained with supply-chain disruption ongoing and our border expected to remain shut until next year at the earliest - adding another layer of complexity to the RBNZ's job of meeting its monetary policy mandates."
Talking in a similar vein in the latest BNZ Markets Outlook publication, BNZ head of research Stephen Toplis says, while noting the RBNZ's "least regrets" approach, that at the moment monetary settings "broadly remain at the same levels" that were seen while we were experiencing the very worst of the economic fallout from the Covid outbreak.
"No matter how pessimistic you might be, it is hard to deny that conditions are now better than at that time and should remain that way even with further Covid outbreaks likely. On this basis, monetary conditions should be tighter than they are now, and least regrets should be turning towards avoiding the threats imposed by an overheating economy."
'Itching to adopt a tighter stance'
Toplis says, however, "this is a very difficult road for the RBNZ to travel".
"While it will be itching to adopt a tighter stance, it will also not want financial markets to get ahead of themselves for fear of the dislocation that rapidly rising interest rates might cause."
Toplis says when the RBNZ produced its May MPS it had effectively assumed a first rate hike by August of next year.
"The data, and anecdote, flow since then must surely mean the Reserve Bank has either become more confident in that assumption or sees the need to tighten sooner. It simply can’t have gone the other way."
Consequently, the RBNZ is left with two options, he says. Either it "green lights" the recent market move or it tries to push back against it.
"The problem it faces is that if it does concur with current market pricing, and says so, the market will inevitably tighten further. It is not clear the Reserve Bank would be happy for this to occur just yet. This being the case, we think the RBNZ [in its interest rate review next week] might produce a statement which acknowledges recent strength in the domestic economy while also continuing to highlights the Bank’s concerns with the economy’s residual risk.
"Difficult to hold a straight face'
"Nonetheless, we think it would be difficult for the RBNZ to hold a straight face and repeat its May MPS comment that meeting its employment and inflation requirements 'will necessitate considerable time and patience'. In our opinion the requirements have already been well and truly met.
"And, yes, there are a number of 'temporary' factors currently at play but once these factors wane we still think inflation and employment conditions will warrant a return to more normal/neutral monetary settings which must mean significantly higher interest rates than is currently the case."
Toplis says even though he believes a hike in the OCR now could be easily justified, he's not forecasting one on the day of the July 14 Monetary Policy Review.
There is, however, "a reasonable chance" that the RBNZ gives a strong nod that its Large Scale Asset Purchase (LSAP) programme problem might be "culminated" earlier than the June 2022 deadline it currently faces.
"It doesn’t need to make any formal announcement in this space as it can simply let its purchase programme slide away to nothing without causing any fuss and bother. However, the Bank might like to send a gentle message as to its possible OCR track by formally changing the date when it may cease purchasing new paper.
"This could act as a soft-signal as to when the RBNZ thinks it might want to have the option of raising the cash rate."