I get asked daily what’s happening with interest rates.
To answer this question, it’s useful to first define what may affect interest rates. The major influence on interest rates is inflation. As inflation rises, interest rates rise to curb inflation (spending). As inflation falls, interest rates fall to spur spending and economic growth.
In August 2008 the average floating residential interest rate in New Zealand peaked at 10.72%. By February 2010 it was 5.98% and it has been relatively flat since then.
Historically low interest rates in NZ
For the past 8 years, interest rates in New Zealand have been historically low. Given these low rates we would normally expect rising inflation, however, inflation has fallen from a high of 5% in 2011 to hover between 0% and 2% (the RBNZ target is 1-2%).
There has however been significant inflation in house prices. In March 2009, the value of housing in New Zealand bottomed out (post GFC) at $568bn. In December 2017, this figure topped $1,067bn. An increase of almost $500bn or 88%.
Over this time there has been significant growth in net migration, however a significant portion of this house price inflation is accounted for by the cheap credit flow into assets such as houses as opposed to spending. Thus, low inflation (as measured by spending) and continued low rates.
This may be changing though, as affordability is becoming an issue. House prices have softened considerably, particularly Auckland and Wellington.
What's the forecast?
Whilst more of a ‘softening of demand’ rather than a ‘property crash’ this may have the effect of funds and credit applied to other spending, in the business and consumer market.
This may see inflation rise in the next 6 – 12 months as spending becomes focussed on business growth and consumer products as opposed to asset acquiring.
The U.S. is already ahead of us in this respect. There have been SEVEN rate hikes in the U.S. since December 2015. Part of this is a response to increased U.S. inflation, but also to catch up on historically low rates (0%-0.25%). History shows rate cuts of 3% are required to spur an economy out of recession. The U.S. Fed rate is currently 2% (interestingly 0.25% above New Zealand which is unprecedented).
There are also inflationary pressures on interest rates in the U.K. and Europe.
With rising rates elsewhere, a switch from asset to consumer spending, and our own OCR at 1.75%, are we likely to see some rate rises in the near future?
The above all points to yes, however this should be caveated by a few different things.
- A sharp lift in interest rates would see a significant softening in the housing and developer market which the government can ill afford given its KiwiBuild programme.
- Inflation remains subdued below the 2% target of the RBNZ.
- Technology is driving lower production costs and therefore lower prices for consumer goods (low inflation).
- Existing margins in bank rates & expected new entrants allow for the OCR to move without overtly impacting the bank rates.
- Flat forward yield curve – the market is currently not pricing any significant movement in interest rates with the 5-year fixed rates sitting only slightly over the current floating rates.
Overall it would be surprising for rates to move significantly in the next two to three years. Expect more of the same, perhaps with increased consumer activity taking up the slack of a subdued housing market.
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