With regard to the monetary policy cycle things are very much in a waiting game at the moment. We have seen the official cash rate rise from 0.25% to 4.25% with the Reserve Bank predicting a rise to 5.5% in the first week of April. We have seen mortgage rates go from below 3% to above 6% and there is a monetary policy shock running through the economy.
That shock has been accentuated by the Reserve Bank on November 23 last year warning that the economy would probably go into recession during 2023. They also predicted that the unemployment rate will rise from just over 3% to just under 6% in a couple of years time.
Their aim in November was to shock householders and businesses away from believing that high inflation would continue and, in that regard, they are to be applauded for bringing out their second monetary policy weapon of scary words. But they have left it relatively late in the tightening cycle to do this and we can already see some evidence of inflationary pressures easing and plenty of evidence that the pace of growth in the economy is slowing.
Many people believe that the economy will go into recession this year, but the chances are if it does it will be a relatively shallow recession. There is a surprisingly strong turn around in net migration flows underway, foreign students are coming back strongly especially in light of the recent Chinese announcement that students will no longer be allowed to study remotely in China and have their degrees recognised back home.
There is also support for the economy from the strong rebound in inbound tourism, underlying growth in sectors like aged care and healthcare, a relatively accommodating level for the Kiwi dollar, good export commodity prices on average, and continuing good job security.
But this of course just makes things relatively confusing because if the economy is only to have a shallow recession if any at all the implication is that interest rates won't necessarily be coming down all that much in the near future. Then again, if we are to judge our outlook for the economy and inflationary pressures on the basis of business and consumer sentiment surveys, the outlook is for a deep recession and a rapid falling away of inflation which would force the Reserve Bank to ease monetary policy aggressively over 2024.
Surveys, including my own, showed sharp deterioration in business and household sentiment after November 23. But more recent surveys, again including my own, show that a lot of the shock value of the November 23 comments from the Reserve Bank has passed. This still leaves sentiment at low levels with businesses showing negative intentions of hiring people and increasing capital investment.
Over 2023 it seems fairly safe to say that spare capacity will build up in the New Zealand economy and inflationary pressures will ease off. But not a single one of us here in New Zealand or overseas has an economic model which can tell us exactly how much economic easing will occur and how quickly inflationary pressures will abate, let alone how quickly the Reserve Bank will react to the easing of price pressures.
So, each week we look deeply at the new economic data to gain some insight into where things are heading including the December quarter inflation numbers which were released a couple of weeks ago. They showed inflation holding steady at 7.2% which on the face of it sounds quite bad. But the important thing is that the result was not another shock as happened on October 18 when the annual number turned out to be 0.6% higher than expected.
The absence of this particular piece of bad news has encouraged everyone in the financial markets to focus back in again on a general view that inflation is being beaten and it's just a matter of time before the Reserve Bank acknowledges this.
For borrowers what this adds up to is this. For the moment there is still some mild upward pressure on the one year fixed mortgage rate as a result of banks factoring in an expectation that the official cash rate will rise to either 5.25% or 5.5%. There has also already been an increase in the two year fixed interest rate offered by some banks, and this has happened without the cost to those banks of borrowing two year fixed rate money actually going up. This means the interest rate increase has been a simple margin grab.
More interesting is the decrease in fixed mortgage rates for three years and longer initiated by some lenders recently. The cost to banks of borrowing money to lend out fixed for periods of two years and beyond has been decreasing in recent weeks in response to hopes of lower inflation in the United States and hopes also that our central bank won't have to take the official cash rate to the 5.5% they have pencilled in for April.
Borrowers should expect that there will be some extreme periods of volatility over the next few months as the markets sometimes get ahead of themselves in expectations of monetary policy being able to be eased then have to pull back the degree of their optimism.
One particular thing to watch out for is the inverse shape of the yield curve for mortgage lending which is now appearing. That is, long term interest rates are now moving below the short term interest rates and people are going to naturally think about going for the lowest cost option which is fixing five years. But one needs to recognise that with the five year fixed mortgage rate near 6.5% this isn't far from the range over the past eight years of roughly 3% to 7%.
It doesn't make much sense to lock in for five years when the rate is near the top of its cycle. The time to lock in was when this rate was at 2.99% two years ago, not now. For most borrowers the optimal thing is going to be taking the pain of the one to two year fixed mortgage rates in the near future in expectation of being able to ride interest rates down when the easing eventually comes.
We don't of course know exactly when that easing is going to come so for some it is going to be a nail biting venture and there will be those who simply feel they cannot take the risk and will lock in for periods of three years or longer.
In deciding what to do a borrower needs to chat with an adviser regarding the level of interest rate risk they can take, including the risk that we are all wrong and inflation goes up so interest rates are 1% higher in a year’s time when you would refix a one year rate locked in now. There is no way to completely remove risk and understand one’s financial and psychological ability to hold steady if things go the wrong way is very important.
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
That shock has been accentuated by the Reserve Bank on November 23 last year warning that the economy would probably go into recession during 2023. They also predicted that the unemployment rate will rise from just over 3% to just under 6% in a couple of years time.
Their aim in November was to shock householders and businesses away from believing that high inflation would continue and, in that regard, they are to be applauded for bringing out their second monetary policy weapon of scary words. But they have left it relatively late in the tightening cycle to do this and we can already see some evidence of inflationary pressures easing and plenty of evidence that the pace of growth in the economy is slowing.
Many people believe that the economy will go into recession this year, but the chances are if it does it will be a relatively shallow recession. There is a surprisingly strong turn around in net migration flows underway, foreign students are coming back strongly especially in light of the recent Chinese announcement that students will no longer be allowed to study remotely in China and have their degrees recognised back home.
There is also support for the economy from the strong rebound in inbound tourism, underlying growth in sectors like aged care and healthcare, a relatively accommodating level for the Kiwi dollar, good export commodity prices on average, and continuing good job security.
But this of course just makes things relatively confusing because if the economy is only to have a shallow recession if any at all the implication is that interest rates won't necessarily be coming down all that much in the near future. Then again, if we are to judge our outlook for the economy and inflationary pressures on the basis of business and consumer sentiment surveys, the outlook is for a deep recession and a rapid falling away of inflation which would force the Reserve Bank to ease monetary policy aggressively over 2024.
Surveys, including my own, showed sharp deterioration in business and household sentiment after November 23. But more recent surveys, again including my own, show that a lot of the shock value of the November 23 comments from the Reserve Bank has passed. This still leaves sentiment at low levels with businesses showing negative intentions of hiring people and increasing capital investment.
Over 2023 it seems fairly safe to say that spare capacity will build up in the New Zealand economy and inflationary pressures will ease off. But not a single one of us here in New Zealand or overseas has an economic model which can tell us exactly how much economic easing will occur and how quickly inflationary pressures will abate, let alone how quickly the Reserve Bank will react to the easing of price pressures.
So, each week we look deeply at the new economic data to gain some insight into where things are heading including the December quarter inflation numbers which were released a couple of weeks ago. They showed inflation holding steady at 7.2% which on the face of it sounds quite bad. But the important thing is that the result was not another shock as happened on October 18 when the annual number turned out to be 0.6% higher than expected.
The absence of this particular piece of bad news has encouraged everyone in the financial markets to focus back in again on a general view that inflation is being beaten and it's just a matter of time before the Reserve Bank acknowledges this.
For borrowers what this adds up to is this. For the moment there is still some mild upward pressure on the one year fixed mortgage rate as a result of banks factoring in an expectation that the official cash rate will rise to either 5.25% or 5.5%. There has also already been an increase in the two year fixed interest rate offered by some banks, and this has happened without the cost to those banks of borrowing two year fixed rate money actually going up. This means the interest rate increase has been a simple margin grab.
More interesting is the decrease in fixed mortgage rates for three years and longer initiated by some lenders recently. The cost to banks of borrowing money to lend out fixed for periods of two years and beyond has been decreasing in recent weeks in response to hopes of lower inflation in the United States and hopes also that our central bank won't have to take the official cash rate to the 5.5% they have pencilled in for April.
Borrowers should expect that there will be some extreme periods of volatility over the next few months as the markets sometimes get ahead of themselves in expectations of monetary policy being able to be eased then have to pull back the degree of their optimism.
One particular thing to watch out for is the inverse shape of the yield curve for mortgage lending which is now appearing. That is, long term interest rates are now moving below the short term interest rates and people are going to naturally think about going for the lowest cost option which is fixing five years. But one needs to recognise that with the five year fixed mortgage rate near 6.5% this isn't far from the range over the past eight years of roughly 3% to 7%.
It doesn't make much sense to lock in for five years when the rate is near the top of its cycle. The time to lock in was when this rate was at 2.99% two years ago, not now. For most borrowers the optimal thing is going to be taking the pain of the one to two year fixed mortgage rates in the near future in expectation of being able to ride interest rates down when the easing eventually comes.
We don't of course know exactly when that easing is going to come so for some it is going to be a nail biting venture and there will be those who simply feel they cannot take the risk and will lock in for periods of three years or longer.
In deciding what to do a borrower needs to chat with an adviser regarding the level of interest rate risk they can take, including the risk that we are all wrong and inflation goes up so interest rates are 1% higher in a year’s time when you would refix a one year rate locked in now. There is no way to completely remove risk and understand one’s financial and psychological ability to hold steady if things go the wrong way is very important.
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
