With the global economic outlook fragile, domestic activity subdued, and inflation at a 13-year low, NZ’s benchmark interest rate (the Official Cash Rate or OCR) looks to be heading nowhere fast. That means floating mortgage rates remain a good option for borrowers, although falls in some fixed-term rates make fixing at least a portion of your loan an attractive option.
The RBNZ’s September Monetary Policy Statement (MPS) and more recent October OCR review should have put many mortgage borrowers at ease. The central bank left the OCR on hold at 2.5% and confirmed its intention to keep it at that level for an extended period. Admittedly, the RBNZ still expects the next move in the OCR to be up, but its official forecasts suggest that move is now unlikely to come before December 2013, six months later than thought back in June (see Figure 1). And, when interest rates do start to rise, the RBNZ expects the increases to be gradual with the peak well below that seen in the past.
Of course, as we all know, forecasts and reality are often two different things and given the current economic environment there are any number of developments that could knock the RBNZ off its intended course. Five factors worth keeping an eye on are:
All of these factors play a critical role in influencing the RBNZ’s view on GDP growth, inflation, and interest rates.
For now, their assumptions suggest the hurdle to moving the OCR (up or down) is high. So let’s take a look at what the RBNZ has assumed and consider where the key risks lie.
The RBNZ expects modest growth in our key trading partners, the September MPS forecasting growth of 3.2% for the year to March 2013, 3.6% in 2014, and 3.8% in 2015. While that is already below- Consensus, the risk of weaker growth remains. Economic and political uncertainty in the euro zone and the US is still the main source of unease, but importantly for NZ, China and Australia have also been showing signs of stress. Throughout September, policymakers in Europe, the US, and China responded to these growth concerns, implementing further material policy changes. However, while these changes have reduced the downside or ‘tail’ risks to growth, they have not eliminated them.
The RBNZ forecasts a decline in the NZD over the next few years. That is significant for three reasons: 1) it dampens GDP growth via reduced export competitiveness, 2) it boosts inflation due to higher import prices, and 3) it goes against the consensus view that the NZD is more likely to go up than down (see Figure 2). In terms of the third point, the stronger NZD is largely based on relativities - New Zealand’s growth outlook looks pretty subdued at sub-3% on average over the next three years, but when compared with many of our key trading partners, we still look a great place to do business. Add in our higher interest rates and expectations that our key commodity prices are set to rise and it’s hard to see the NZD falling. On that basis, the exchange rate also presents a key risk to the RBNZ’s forecasts.
The Canterbury rebuild is a key factor supporting the RBNZ’s view that growth will pick up, inflation pressures will build and, ultimately, the OCR will rise. Hence, any change in the timing, magnitude or duration of reconstruction is critical to the future direction of the OCR. The RBNZ has assumed reconstruction will gain momentum from the end of this year and peak in late 2014/early 2015 (see Figure 3). The most recent economic data suggests that profile is broadly on track. Still, the risk is that near term GDP growth is softer than expected, due to further delays or the pickup in reconstruction work being offset by reduced demolition and emergency repair work.
However, beyond mid-2013, the risks to growth and inflation still look on the upside. The eventual cost of the rebuild could well be more than the $20bn currently estimated, but the RBNZ’s assumptions made about the indirect effects of the rebuild could also be too conservative. Specifically, the RBNZ predicts that the concentrated and coordinated reconstruction effort will limit the impact on house prices and construction costs. However, house prices are already rising faster than forecast (see comments below), consumer spending is picking up in housing related categories, and construction costs look under pressure when the building work has only just begun.
House price growth is projected to reach 5% this year before easing back through 2013 as supply comes on stream (via an increase in the number of sellers and a pickup in residential investment) and high debt levels constrain households ability to borrow (see Figure 4). However, data from the REINZ suggests that house price inflation could be stronger than the RBNZ expects. House prices in Auckland are already pushing into double-digit territory, the nationwide house price index is running at 6.1%, and there are signs that low interest rates are fuelling momentum outside of Auckland and Christchurch.
The RBNZ is picking that a significant offset to the growth in Canterbury will come from tighter fiscal policy (i.e., lower growth in government spending and increased revenues) as the government attempts to return to surplus by 2015. So far the signs are that the Government will struggle to meet its challenge within the intended timeframe. If that is the case, GDP and inflation are likely to be stronger than expected.
Basically, it is likely to take a significant global or domestic economic event to see the OCR move from its current 2.5% rate over the coming year. For example, a breakup of the euro zone, a collapse in emerging market growth or soaring New Zealand unemployment.
The strong NZD remains a key frustration for the RBNZ, but on its own is unlikely to trigger a rate cut (a point made loud and clear in a recent speech by the new RBNZ Governor Graeme Wheeler). Rather, it is more likely to result in a lower-for-even- longer OCR as falling import prices take the pressure off inflation elsewhere.
For borrowers, the long period of interest rate stability implied by the RBNZ’s September MPS forecasts mean floating rate mortgages are still a good option as they offer plenty of flexibility. However, with financial markets continuing to assess interest rate cuts as the greater risk, shorter term fixed mortgage rates also look attractive. In fact, at the time of writing, rates in the 6-month to 2-year space were all sitting below the floating rate. So, if you believe the chance of a cut in the OCR is limited, or indeed, you just want some certainty, then locking-in at least a portion of your loan at one of these lower rates would seem to make good sense.
Donna Purdue is the Economist at Kiwibank.
Donna has been forecasting, researching, and commenting on developments in the New Zealand economy for over 13 years and joined Kiwibank as its Economist in March 2011. Prior to joining Kiwibank, Donna worked as a Senior Economist for Westpac where she focused on developments in New Zealand’s household and government sectors. She has also worked as an Economist for the New Zealand Institute of Economic Research, the British High Commission, and Ord Minnett Securities.
Donna has a First Class Honours Degree in Social Science, majoring in Economics, from Waikato University. Her keen interest in economics is backed by a passion for educating others. She believes that helping people and businesses understand what’s driving movements in interest rates, exchange rates, inflation, and unemployment will help them make more informed financial decisions.
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