Reserve Bank Governor Graeme Wheeler surprised just about everyone on March 10 by cutting the Official Cash Rate and he looks set to cut again as soon as April 28. Very low global inflation, slowing growth overseas and a stubbornly high New Zealand dollar pushed Mr Wheeler into a rate cut he clearly would have preferred not to make, as he indicated in a speech as recently as February 3. But lower rates overseas and weak inflation expectations here pushed him over the edge.
One factor he cited was concern that those falling inflation expectations could turn into a self-fulfilling prophecy that locked in inflation below the Reserve Bank’s 1- 3% target band. The U-turn surprised most economists and sparked an initial fall in the New Zealand dollar. “A fall in expectations is concerning, because it will dampen wage and price setting behaviour over the time horizon relevant for monetary policy,” the Reserve Bank said in its Monetary Policy Statement (MPS) with the 25 basis point cut in the Official Cash Rate (OCR) to 2.25%. The MPS statement also included the bank’s forecast that 90 day bill rates – a proxy for the OCR – would fall another 25 basis points by the middle of the year, which Mr Wheeler confirmed meant the bank expected to cut one more time in 2016 to 2.0%. Most economists see the OCR being cut to 2.0% by August 11 at the latest.
ANZ and ASB see it being cut as low as 1.75% by the end of the year. However, not all of the surprise cut was passed on to floating rate borrowers and initial signs are that banks are keen to hold on to some of the fall in interest rates to bolster their net interest margins. ANZ, Westpac and BNZ only passed on 10 basis points of the 25 basis point cut to floating rate borrowers. They argued that their costs of foreign funding were higher, but there’s debate about that. The Reserve Bank said the effect was only mild and they expected all of the 25 basis points of cuts to be passed on to floating rate borrowers. ASB and Kiwibank passed on up to 20 basis points of the cut, while Co-op Bank and HSBC passed it all on.
Banks have put their margins under pressure over the last year with aggressive discounting in fixed rate mortgages, but the prospect of hefty losses from dairy lending may be forcing the banks to blunt some of their sharper prices. Wholesale swap rates fell 20-25 basis points after the rate cut, increasing the pressure on banks to pass some or all of it on to fixed rate borrowers. The initially subdued response from the banks may force the Reserve Bank to cut the OCR even further to get the ‘bang for its buck’ it needs to meet its inflation target. A surprising rebound in the New Zealand dollar to 2016 highs of 68.5 USc will also increase the pressure for more rate cuts. The US Federal Reserve lowered its forecast for interest rates in the week after the Reserve Bank cut, which added yet more impetus for lower rates globally and weakened the US dollar.
Dairy prices also kept falling through March as European dairy farmers continued to increase production. Europe removed its quotas on dairy exports last April, unleashing a wave of new production. The European Commission even announced new subsidies in March to allow continued over-production. The Reserve Bank’s initial reluctance to cut was also soothed by a further slowing in Auckland’s housing market, although activity and prices outside of Auckland continued to surge. Prices and volumes were broadly flat in Auckland in February, although the jury remains out on whether the slow-down over the summer is more than temporary. Data from March due in April will give a better indication.
Meanwhile, despite the latest dairy slump and slower global growth, the New Zealand economy is still trucking along with GDP growth of over 2.5% and jobs growth of 1-2%. A record summer for tourism, robust consumer spending and plenty of construction in Auckland and Christchurch are keeping people working, earning incomes and paying their rents and mortgages. Low petrol prices, high migration and plenty of equity in house values are helping to fuel spending and jobs growth in most cities. The bottom line: The Reserve Bank surprised most with a rate cut on March 10 and could cut again as early as April 28. Inflation remains weak and deflationary headwinds continue to blow from the rest of the world, pushing down on interest rates. The big four banks have initially been reluctant to pass on the bulk of the rate cuts to mortgage rates, pointing to higher foreign funding costs, although the Reserve Bank is skeptical.
ANZ and ASB see it being cut as low as 1.75% by the end of the year. However, not all of the surprise cut was passed on to floating rate borrowers and initial signs are that banks are keen to hold on to some of the fall in interest rates to bolster their net interest margins. ANZ, Westpac and BNZ only passed on 10 basis points of the 25 basis point cut to floating rate borrowers. They argued that their costs of foreign funding were higher, but there’s debate about that. The Reserve Bank said the effect was only mild and they expected all of the 25 basis points of cuts to be passed on to floating rate borrowers. ASB and Kiwibank passed on up to 20 basis points of the cut, while Co-op Bank and HSBC passed it all on.
Banks have put their margins under pressure over the last year with aggressive discounting in fixed rate mortgages, but the prospect of hefty losses from dairy lending may be forcing the banks to blunt some of their sharper prices. Wholesale swap rates fell 20-25 basis points after the rate cut, increasing the pressure on banks to pass some or all of it on to fixed rate borrowers. The initially subdued response from the banks may force the Reserve Bank to cut the OCR even further to get the ‘bang for its buck’ it needs to meet its inflation target. A surprising rebound in the New Zealand dollar to 2016 highs of 68.5 USc will also increase the pressure for more rate cuts. The US Federal Reserve lowered its forecast for interest rates in the week after the Reserve Bank cut, which added yet more impetus for lower rates globally and weakened the US dollar.
Dairy prices also kept falling through March as European dairy farmers continued to increase production. Europe removed its quotas on dairy exports last April, unleashing a wave of new production. The European Commission even announced new subsidies in March to allow continued over-production. The Reserve Bank’s initial reluctance to cut was also soothed by a further slowing in Auckland’s housing market, although activity and prices outside of Auckland continued to surge. Prices and volumes were broadly flat in Auckland in February, although the jury remains out on whether the slow-down over the summer is more than temporary. Data from March due in April will give a better indication.
Meanwhile, despite the latest dairy slump and slower global growth, the New Zealand economy is still trucking along with GDP growth of over 2.5% and jobs growth of 1-2%. A record summer for tourism, robust consumer spending and plenty of construction in Auckland and Christchurch are keeping people working, earning incomes and paying their rents and mortgages. Low petrol prices, high migration and plenty of equity in house values are helping to fuel spending and jobs growth in most cities. The bottom line: The Reserve Bank surprised most with a rate cut on March 10 and could cut again as early as April 28. Inflation remains weak and deflationary headwinds continue to blow from the rest of the world, pushing down on interest rates. The big four banks have initially been reluctant to pass on the bulk of the rate cuts to mortgage rates, pointing to higher foreign funding costs, although the Reserve Bank is skeptical.
