The chances are very high that at some stage this year the Reserve Bank will capitulate to the evidence of falling inflation and announce monetary policy will be eased a lot sooner than the second half of 2025 which they have pencilled in. Their reluctance to express any happiness about the inflation track currently is perhaps understandable when we consider these important points.

The ANZ’s monthly Business Outlook Survey shows that a net 50% of businesses plan raising their selling prices over the coming year. This is only slightly lower than 59% a year earlier and remains twice the long-term average which has prevailed while inflation averaged just above 2%.

Businesses are still saying that their cost pressures are strong, and they want to build margins. Until that desire changes the Reserve Bank cannot take the risk of easing monetary policy only to have to suddenly tighten it again perhaps in 2025.

Another problem is that although the labour market by one measure is at its loosest point in the past 14 years, there is as yet scant evidence that this is leading to a substantial slowing in the pace of wages growth. We all expect such a slowing will occur as the market is swamped with record net migration inflows which have boosted the population 2.5% in the past year.

But the latest data still show private sector wages growth at just over 7% whereas the average has been just 3.3%.

Then there is the problem that although the rate of inflation is now well down from the 2022 peak of 7.3% at 4.7%, this is still much too far away from the target range of 1% - 3%.

But if these problems remain, why is it that the cost to banks of funding fixed rate loans in the wholesale markets has fallen so much in recent months? The one year swap rate banks pay to borrow fixed then lend fixed one year has fallen to around 5.3% from 5.9% four months ago. The three year swap rate has fallen to near 4.5% from 5.4%.

These declines largely reflect much lower wholesale interest rates in the United States as the markets there anticipate easier US monetary policy this year and next starting as soon as March. The Federal Reserve have said they will ease three times this year. The markets have priced in six rate cuts.

This means there is a risk that the markets have got a bit ahead of themselves. However, the key issue here in New Zealand is that although bank funding costs have fallen tremendously, they have yet to make more than desultory cuts of 0.1% here and 0.15% there.

Their lack of mortgage rate cuts has taken the margins they earn on fixed rate lending to unusually high levels. Why is this happening? Probably because the Reserve Bank has made it clear to them that although theoretically, they can cut their lending rates because of lower funding costs, the Reserve Bank would prefer they not do so in order to keep monetary pressure on the economy strongly downward.

The question is this. With our economy possibly back in recession again and inflation falling away, when will the Reserve Bank feel that the outlook is safe enough that they can first signal to banks that cutting margins is okay, then signal to the markets that monetary policy easing before mid-2025 is going to happen?

We don’t know. It is like asking when the war will end in the Middle East or Ukraine. Perhaps one date to keep an eye on is February 7. That is when we will get December quarter wages and employment data from Statistics NZ. If the numbers are weak then we could see (actually you and I won’t see behind the closed doors) the Reserve Bank let banks know they would be relaxed should they cut rates to reflect lower funding costs.

After that the next important date will be the official Reserve Bank policy review on February 28. No change in the timing of policy easing is likely then. But come the next review on April 10 some expression of happiness regarding the inflation track could come along.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets.

​By Tony Alexander

Central banks sometimes like to surprise the financial markets in order to keep people on their toes. But that is not what has just happened here in New Zealand. This week the Reserve Bank conducted their regular review of the official cash rate and met universal expectations of no change. The rate still sits at the 5.5% level it was taken to at the end of May this year.

The next review of the cash rate doesn't happen until the end of February and by the time we get there we will have in hand a lot more data on the New Zealand economy and a lot more information regarding the speed with which inflation is falling. At the moment the inflation rate is 5.6% which is down from the peak last year of 7.3%. That is good. 

But at 5.6% inflation is much too far away from the 1% to 3% target band to allow the taking of any risks by the Reserve Bank. In particular, they are not going to take the risk of easing monetary policy without solid evidence that the loosening of New Zealand's labour market is leading to a solid reduction in the pace of wages growth. 

We can tell from various indicators that the record net migration inflow into New Zealand over the past year of 119,000 people has greatly changed the dynamic in the labour market in favour of employers in many sectors. Economic theory and history tell us that with more employees available the pace of wages growth will slow down. 

But as yet we have zero data in hand proving that this is happening. In fact what we do have are many businesses who require skilled people still saying that finding staff represents a problem. We also have a great number of young Kiwis leaving the country for a variety of reasons and a key factor will be the low level of wages compared with Australia in particular. 

Growing awareness of the wage disparity of New Zealand with Australia could keep our pace of wages growth relatively strong in the near future. Or maybe not. We simply don't know, and this is one of the many uncertain factors the Reserve Bank has to take into account when it considers the speed with which inflation will go down from here. 

In three months time we will also have a lot more information with regard to the strength of recovery in the tourism sector. This is a very important export for New Zealand and the most recent data showed that visitor numbers were running at about 86% of their level ahead of the global pandemic. The Chinese market has yet to kick in and when it does this will be very positive for our economy.

But for the moment China’s economy looks relatively weak with consumers over there pulling back on spending in order to rebuild savings in the face of rising unemployment and wealth lost in the retrenching property sector.

Come the end of February we'll also have a better idea of how bad the El Nino weather pattern will be and whether or not deep drought conditions will have set into the east coasts of the North and South Islands. Already we can see evidence that farmers have closed their wallets from about four months ago and regional economic weakness matters a lot for the New Zealand economy.

There is also economic weakness coming from falling house construction in New Zealand. The strong increase in property listings from early 2022 has encouraged buyers to focus on properties already built rather than putting in orders for new houses to be constructed. This situation will probably change quite strongly from early in 2025, but before we get there falling house construction will act as a drag on the economy. 

There will be some slight offset from rising house prices. House prices on average in New Zealand bottomed out in May and since then have increased by 4%. My monthly surveys of residential real estate agents and mortgage brokers show good but not rapidly rising numbers of both first home buyers and investors coming into the market. I cannot see any evidence of a frenzy in the real estate market and in particular see no evidence that investors are once again jumping boots and all into the market just because interest expense deductibility will be restored earlier than previously expected. 

Nonetheless, when we offset falling construction against rising demand from the record net migration inflows pushing young buyers out of renting and into buying it seems highly reasonable to expect that house prices will continue to rise through 2024. 

Rising house prices can generate a positive spending impact on the economy, though I doubt that the effect will amount to much over 2024 given that prices are still well down from where they were at the end of 2021.

The key determinant of strength in the housing market is going to be the speed with which interest rates decline, and the speed with which interest rates decline will be partly influenced by the degree of strength in the housing market and the impact which it has on wider decisions of consumers whether to spend or not. 

Taking all these considerations and many others not mentioned here into account the Reserve Bank is not going to be taking any risks with monetary policy for quite some time. But if we're lucky, come the next official cash rate review late in February we will have data in hand showing slowing wages growth and a further decline in the inflation rate. That means at that time the Reserve Bank may just make a positive comment about scope for monetary policy easing in the second half of 2024. 

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets.

By Tony Alexander

​On the face of it one might think that news three weeks ago of New Zealand’s inflation rate falling to a lower than expected 5.6% from the previous 6% and the peak of 7.3% might cause some sizeable easing of wholesale interest rates. Unfortunately for borrowers this has not proved to be the case.

The one year swap rate at which banks borrow money domestically to lend fixed for one year has only retreated to near 5.7% from 5.9% a month ago while the three year rate has only eased to 5.4% from 5.5%. Six months ago these key rates were 5.7% and 4.7% respectively. What we can see is that the longer term borrowing costs have been pushed quite a bit higher.

This is not really because of developments in New Zealand, but instead a decrease in confidence in the United States that monetary policy there will be speedily eased through 2024. The US labour market has proved a lot stronger than expected and contributed to the economy growing at almost a 5% annualised rate during the September quarter.

Levels of and movements in borrowing costs in the United States tend to affect rates in other countries and the result has been extra increases in bank fixed mortgage rates, especially for the medium to long terms. But why the rise over the past six months in the common one year fixed mortgage interest rate from 6.7% to 7.3%?

About half of this 0.6% rise can be put down to banks getting their lending margin from below average levels. The other, more recent, half looks purely to be a profit boosting move taking advantage of the fact that most people looking to fix their mortgage rate are opting for either one year, 18 months, or two years. Few people are fixing three years and longer.

People are doing this because of the ongoing wide belief almost all of us have that interest rates are at about their cyclical peaks right now and the next big changes will be downward – though not for some time. The problem here of course is that many of us have been of this view both here and offshore for a year now and yet rates have continued to climb higher.

This is because inflation globally is proving to be a lot “stickier” than earlier assumed. It can be seen in New Zealand when we look behind the headline 5.6% inflation rate to see what is happening without the special factors which can move things around quite a bit. For instance, if we strip away goods traded internationally and therefore affected mainly by developments in the rest of the world, what we call the non-tradeables inflation rate in New Zealand is 6.3%. The peak was 6.8% only six months ago.

There are also other pieces of data telling us and the Reserve Bank that inflation is not set to fall away sharply. The net proportion of businesses in the ANZ Business Outlook survey saying they intend raising their prices in the coming year averages 25%. The latest result is almost twice that at 47%, up from 44% a month earlier.

One measure of consumer inflation expectations from ANZ and Roy Morgan has also just risen from 4.2% to 4.5%.

The next big change in New Zealand monetary policy will be an easing. But the chances are now not good that this will happen before the middle of next year, and some forecasters predict a further rise from the current 5.5% for the official cash rate may in fact be made.

Yet despite pessimism about interest rates the housing market continues to rise. Average prices nationwide have now gained 2.8% in four months led by Wellington near 4.8%, then Auckland 3.8% and Canterbury 2.8%. The three cities are leading price rises and some of this will reflect record net migration gains over 110,000 in the past year.

Migrants tend to go to the cities whereas people leaving tend to go from all around the country – especially the near record 43,000 flow of Kiwis out of NZ in the past year.

Prospects remain positive for house prices continuing to edge higher, but not at a fast pace for the next year given the ongoing restraint from high interest rates. But with falling construction until 2025, strong population growth, and a change of government bringing investors back into the market, the upward leg of the house price cycle which usually lasts five or so years, does look like running on from here as we enter (November) month six.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets. By Tony Alexander

My thoughts about what the optimal interest rate risk strategy is for most home buyers haven’t changed much over the past month even though there are a few fresh items to consider regarding prospects for our growth and inflation.

On the good side for inflation we have in hand data showing that retail spending volumes fell by 1% during the June quarter, or by 1.8% if we focus on core areas of spending. This is a greater decline than expected and suggests that the Reserve Bank could be achieving greater weakness in consumer spending than they might need to get inflation under control.

However, given that the links between changes in household spending and eventual changes in inflation are extremely clouded in this post-pandemic environment we are unlikely to see the Reserve Bank water down their policy warnings anytime soon.

In fact, it is probably less the state of household finances that they are keeping an eye on than those for our exporters hit by the biggest change in recent times – China’s economy.

One-third of our export receipts come from China and virtually all data released regarding the Chinese economy over the past three months have been worse than expected. Businesses are experiencing falling sales as foreign economies cool. Builders are closing down as consumers refrain from buying and a stock of 50-70 million apartments sits unused.

Regional governments are laden with debt and facing falling receipts because of reduced land development. Consumers have 80% of their wealth in housing and prices are falling while many projects sit unfinished because of a lack of fresh finance and lack of cashflow generating new sales.

Already the weakness in China’s economy has led to falls in prices for NZ’s major export commodities and further declines look likely of a magnitude history tells us we cannot reasonably predict. Farmers have seen periods of weak prices many times over the past couple of centuries and they know how to handle reduced incomes – their spending will be slashed.

This will weaken the overall NZ economy. But the biggest impact will be in the regions. This then will be yet another factor helping to justify my long-expressed view that this upturn leg of the housing cycle will be one led by the cities – Auckland, Wellington, and Christchurch.

The greater the weakness in China the greater will be regional economic weakness here. That means the timing of the first cut to the official cash rate will be earlier and potentially the speed of decline faster than the Reserve Bank have indicated.

But these are early days for China’s slowdown and just as there is a risk average people are not even aware of the rural decline and under-estimate it, so too could we be over-emphasising the China slowdown when we consider that the Chinese economy is still expected to grow by over 4% this calendar year.

But to the extent China slows down and monetary policy gets eased through 2024, there is an offset to some degree from another new factor. The government’s accounts are deteriorating rapidly in the face of weakening tax receipts from companies. This means Treasury will need to issue more bonds to finance the deficit and this implies some extra upward pressure on medium to long-term interest rates.

In fact, some of the recent rise in US interest rates which has fed through to higher borrowing costs here can be put down to larger than expected bond issuance now anticipated in the United States.

For borrowers the picture remains very clouded, and we should not ignore the possibility that no signal of inflation comfort is forthcoming from the Reserve Bank until well after the general election. Speaking of which, with the polls suggesting a change in government we can anticipate tax rule changes which should bring investors back into the market as buyers.

But the extent to which investors will return is unclear. Interest rates are at high levels and the numbers do not stack up for many, especially with regard to needing a 35% deposit for making a purchase with a mortgage. But I can tell from my monthly survey of real estate agents that some extra investors are already appearing in the market.

But they are nowhere near as prevalent as first home buyers who are entering the market in greater and greater numbers. Fears of prices falling after making a purchase (FOOP – fear of over-paying) have almost disappeared. FOMO meantime has climbed rapidly, perhaps encouraged by a 15% nationwide fall in the stock of property listed for sale over the past seven months.

In fact, in Wellington stock levels are down by 49% from the peak in August last year while Auckland’s stock is down by 20%. The ability for buyers to pick and choose is easing and once the election is out of the way the spring and summer real estate market could be unusually active – in the cities at least. In the regions some caution is going to be creeping in.

For now, I retail my view that house prices on average will rise about 5% this year, 10% over 2024, and something greater through 2025.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets. By Tony Alexander

The list of indicators showing improvement in the residential real estate market around the country on average has continued to grow over the past four weeks since my previous column. From the REINZ we have data in hand showing that after adjusting for seasonal factors sales rose almost 20% in the June quarter while prices in the month of June improved by 0.7% after sitting flat over the previous two months.

From my latest survey of residential real estate agents we can see that for the first time since the very end of 2021 there is a greater proportion of agents saying that buyers are worried about missing out than say they are worried about over-paying for a property.

This is not to say that buyer jitters have really set in and that the market is about to soar. Interest rates remain at levels designed by the Reserve Bank to restrain the pace of growth in the economy, incomes, and employment and we can truly only guess as to when they fall.

The first monetary policy easing may come before the middle of 2024, but before we get there, we need to see considerably more easing of inflation measures than we have seen to date. For instance, the headline rate of inflation has just fallen from 6.7% to 6.0%. But underlying inflation remains stuck near 6.5% and in fact for the June quarter was more than the Reserve Bank expected.

So, not only is no easing of monetary policy imminent, but the Reserve Bank are also unlikely to signal high comfort with the track for inflation for a considerable time – probably not ahead of the general election on October 14.

Speaking of which, while I can cite literally a dozen indicators from my real estate agent survey showing the market improving, I cannot see any evidence that other than investors paying with cash are showing increased market presence.

There is still a net 12% of agents saying that they are seeing fewer investors in the market. If the election produces a win for the National Party, then we can expect restoration of the ability of people running rental property businesses to deduct all their expenses including interest costs, while the brightline test will be taken from ten years back to two years.

At this stage I am not detecting many investors willing to take a punt on the election outcome and purchase now. But if National win then it seems reasonable to expect the return of many investors and an acceleration in the pace of house price rises.

A net 59% of agents say that they are seeing more first home buyers in the market. This is the highest reading since October 2020 and there are a variety of factors explaining why young people have been re-entering the market in large numbers since February this year.

House prices on average are down 18% from their late-2021 peaks. Banks are making credit more readily available. Wages growth has outpaced the increase in the cost of living, deposits saved up have grown, and job security is high.

I cannot as yet detect much of an increase in the number of owner-occupiers buying then selling or selling then buying. But such activity will pick up perhaps when there is slightly more confidence that interest rates are going to fall.

A key thing which potential property buyers need to keep in mind however is that the quantity of stock available to choose is shrinking. Nationwide the number of properties available for purchase was 14% lower at the end of June than the end of December last year. But it is when we look at the change at the regional level, we start to get interesting insights perhaps supporting my view that the cities will lead the cycle this time around.

In Christchurch listings peaked in March and have so far fallen by 10%. But in Auckland they peaked in August last year and are now down by 18%. In Wellington they also peaked in August 2022, but the fall to date has been about 44%. Stock is drying up in the capital and 2021 taught us an important lesson. Stock levels matter a lot when it comes to price movements.

Back then we saw prices rise 11% in a five month period from July to November in spite of negative migration flows, rising mortgage rates, the return of LVRs in February, strengthening for investors in May, and tax changes dissuading investors from buying late in March. Why did prices jump despite these negative factors?

Probably because the stock of properties for sale fell to a record low near 13,500 in July that year. People could not find a property to purchase, and FOMO rose.

Now, there seems to be so far only mild awareness that stock levels are falling. This is likely to change. History tells us that when dwelling sales rise there are more vendors which step forward. But the new flow of buyers is larger and stock levels decline.

Come the first half of next year stock levels are likely to be back below 20,000 and this will be one of many factors likely to produce an average nationwide gain in house prices through 2024 of perhaps 10%. Other factors will include falling interest rates, strong net migration inflows, and falling new house construction.

For the moment, regarding interest rates – banks have recently increased fixed lending rates because their wholesale borrowing costs have been pushed up by rate rises in the United States. The chances are that now, finally, surely this time, rates have hit their peaks. But declines seem unlikely until very late this year.

If I were borrowing at the moment, I might loom quite favourably at the 18-month term, or at least explicitly recognise the many uncertain factors in play by spreading my risk over one and two years.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets. By Tony Alexander