RBNZ and interest rates - should you be worried?

This week we had a question from a client which prompted this blog. They said they wanted to fix their mortgage at the lowest possible rate and they asked me where I saw interest rates going. 

It was a good question and it got my grey cells working. I'm unsure I can answer it with any true certainty. Historically, those game enough to forecast interest rates have proven to be wrong.

What I can tell you is that the Official Cash Rate (OCR) is set by the Reserve Bank of New Zealand (RBNZ) and changes made to the OCR tend affect floating and short-term interest rates. Long-term rates are influenced more by the rates set by offshore lenders to our NZ banks and by global events.

Many people expected the RBNZ to decrease the OCR on 29 October 2015. For my part, I didn't believe they would (refer to my October blog on interest rates) and as we know, that belief has proven to be correct.

So why did the RBNZ hold the OCR? Possibly because it thought it might need some additional ammunition in its back pocket if global economic conditions deteriorate further and if inflation in NZ doesn't respond upwards. Delaying cutting the OCR gives the Reserve Bank Governor some potential firing power in other words.

Alternatively, the Governor may have felt a cut to the OCR wasn't needed to stimulate our economy on the basis spending via credit and Eftpos cards has recently increased, as have dairy prices.  

Personally, I think the RBNZ didn't reduce the OCR for all the above reasons. Additionally, I think it wanted some time to evaluate how the new LVR restrictions and the recently introduced tax requirements would affect consumer behaviour.  

Remember it pushed for the introduction of LVR restrictions on the basis that stability to our financial system could be affected if there was a dip in property values. Couple this with the fact that the new tax provisions may affect residential buyers' behaviour and take some heat out of the market, and the RBNZ may have thought it unnecessary (due to these two factors) to change the OCR at the October review date. Far safer to play a wait and see game. Let time lapse so as to demonstrate conditions, enabling the Governor to evaluate options. Whatever the reasoning, the OCR was left unchanged, which should have meant interest rates remained static. This, however, hasn't occurred and we've seen downward movement in some rates, including long-term rates.  

The next OCR review date is 10 December 2015. What is the RBNZ expected to do? The jury is out at present. To make its decision, it will have to weigh up a variety of factors: current positive economic conditions with respect to growth in services, construction, tourism, immigration and house price increases, together with consumer confidence rising, against risks that dairy prices will retract, labour markets will soften and wage growth will be almost non-existent due to positive net migration numbers.

The Governor will also have to turn his mind to the state of the NZ dollar which remains stubbornly strong. Recently, there have been murmurs monetary tightening in USA will occur. For the reasons noted in my previous blog I'm unsure that even if the U.S. Federal Reserve (Fed) does tighten as they continuously threaten, it will mean our dollar will fall and our exporters will gain relief. Consequently, I'm doubtful exports will increase. Australia, China and other Asian countries' growth is slowing and demand is expected to decline. 

Finally, I expect the RBNZ will be monitoring and assessing global risks. It will consider the slow growth prospects of China, East Asia and Europe. In particular, its thoughts will rest on the recent inflation predictions made by America and England. Global inflation is low and is forecasted to remain so. Worryingly, data suggests it will plummet further, despite the highly stimulatory money policies that have been implemented. For example, central banks have taken steps to ensure internal interest rates fall and remain low (or non-existent) and there's been an eye-watering amount of money printed. I don't believe these policies will work for the reasons I've set out in my blog. We are in a new environment and cannot continue to use old tools to fix what is essentially a new problem – deflation rather than inflation.

Forecasts for New Zealand are little better. Internally our own data has shown NZ economic growth is below what was anticipated.  In the medium term, if inflation is to return to 2%, I think some action by the RBNZ is going to be needed. Whether this means the Governor will decrease the OCR on 10 December 2015, however, is another thing. He may decide more time is required to evaluate where dairy prices are likely to go, what effects the new bright-line test and LVR rules will have, and what action (if any) the USA have taken and how that has affected our NZ dollar. Thus the RBNZ may well leave the OCR as its current level of 2.75%.

If the RBNZ does decrease the OCR, the usual scenario may result: variable and short-term interest rates may decrease and banks may even decrease long-term rates in an effort to attract new customers. Then again, perhaps not. Recently I was in Australia. At that time, the Reserve Bank of Australia decreased its OCR and the registered banks surprisingly increased their short-term interest rates, possibly on the basis that they needed to attract term deposit funds to meet the new capital requirements imposed upon them. This is a good lesson to us all – a cut to the OCR doesn't necessarily mean our banks will automatically decrease interest rates; thus we shouldn't count our chickens before they hatch. Rather, we should be using interest rate mitigation strategies: practise interest rate tranching to obtain a 'best average' rate and build in a buffer just in case rates move upwards. 

Of course if the RBNZ does decrease the OCR it will be wary of that decrease translating into lower interest rates. This is because, ultimately, lower interest rates may serve to stimulate the housing market. I think this concern could be alleviated, however, by the effect the new LVR restrictions and recently introduced tax rules bring about. Certainly if appearances are to be believed, the market in Auckland has recently slowed somewhat. Fewer properties are selling at auction in Auckland (although they are selling post auction) and there is a noticeable pullback by foreign buyers. That said, Auckland still has a housing shortage and only an increase in supply of housing is going to fix this. All things being equal, where demand outweighs supply, prices will lift, although in Auckland, in my opinion, I expect the price rises won't be as dramatic as previously experienced and will be at a slower pace. 

Outside of Auckland it's a different story. Data has shown regional house prices have lifted, possibly courtesy of Auckland buyers being enticed to purchase property with greater yields and lower LVR restrictions. This puts the cat among the RBNZ pigeons. Recall the LVR restrictions were implemented on the basis that stability to our financial system could be affected if there was a dip in property values. It seems to me, therefore, that if property prices are increasing dramatically outside of Auckland, the issue has just been shifted into the regions and the implemented solution of LVR policies hasn't worked as anticipated.  

Aside from changing the OCR, what does all of this mean for the RBNZ? Maybe wanting to introduce new policies to curb the market such as increasing the LVR in the regions to 30%. Possibly it will consider additional macro policies such as the introduction of debt to income policies (e.g. banks not to permit debt to exceed 4 times income) like they have done overseas.  

Where will this leave people? Overall, they won't be complaining about having a mortgage, nor will they be worrying about obtaining a loan at the lowest interest rate possible. Rather, they'll be lamenting about actually being able borrow the funds they need to achieve the things they want to realise.

That said, if you are currently reviewing your loans, you may want to wait until after the December OCR review date when I think odds are the RBNZ will reduce the OCR, potentially inducing a decrease in short-term interest rates and saving you funds on your mortgage repayments.

Happy number crunching.