By David Hargreaves
New Zealand will be treated to something of a rarity next week.
The Reserve Bank’s call on interest rates to be made on Thursday December 10 is very much ‘live’ – by which I mean it’s by no means clear ahead of time what the verdict will be.
Market pricing of wholesale interest rates has suggested it’s a 50/50 call whether the Official Cash Rate will be cut by quarter of a percent, or left alone at the current 2.75%. Perhaps there’s just slightly more of a feeling that there’ll be no change.
The last time we had such an in-the-balance decision was in the lead-up to June’s decision at which point the RBNZ made the first of what became three consecutive cuts to rates. And before June you had to go back about a year to the previous last time when we went into a rates decision week really not being sure which way the RBNZ would call it.
For what it’s worth, I’m picking that rates will be unchanged next week – though if I tell you that I also picked no change in June and got that one wrong, you might say my opinion’s not worth that much! But we try.
Anyway, I still think the RBNZ’s looking to take its cue from the US Federal Reserve. And I think that providing the US employment figures out this weekend don’t show some sort of nasty reverse in the past month, then the Fed will make its long awaited interest rate hike on December 17 our time.
If the RBNZ is, after release of the US employment figures, reasonably convinced the Fed will hike rates then it is to be imagined our central bank would feel reasonably comfy with maintaining its ‘watch and wait’ stance articulated in the last rates review on October 29. That’s the theory anyway…
But difficult as it may be to decide which way the RBNZ’s going to move on rates next week, it actually starts to look even harder to work out what will happen next year. Which way will rates move next, and when?
According to the RBNZ’s September Monetary Policy Statement projections, the central bank sees one more interest rate cut (to 2.5%) yet, but it has been pretty coy about when that might be – basically any time between now and the middle of next year. But what then? Do we go into a period simply of no movement, or might we see as economists at two of the major banks are suggesting, the need for further reductions in rates as 2016 goes on?
Waiting on rates
I suspect quite a few homeowners are starting to take a bit of a wait-and-see approach.
From my perspective, as one who is all in favour of this country improving standards of financial literacy (and the finance company sector meltdown in 2007-10 showed how far we had to go), I find it gratifying to see how savvy the country’s mortgage holders appear to now be about getting themselves the best deal on interest rates.
The Reserve Bank compiles monthly figures outlining who owes what on mortgages, over what terms and at what interest rates.
After the Global Financial Crisis in 2008 mortgage holders started clambering out of fixed rate mortgages and into floating, with far more mortgages ending up floating than fixed. This trend then started to reverse in 2012 and by mid-2013 there were again more fixed than floating mortgages. As at October 2015 just over 75% of mortgages were at fixed rates.
But interestingly, within the fixed rate statistics there’s been some significant moves in recent months as people have clearly reacted to the change in direction from the RBNZ, from an on-hold bias after moving the OCR up last year to 3.5% from 2.5% back to an easing bias from June this year.
As of January some 60% of fixed rate mortgages were for terms in excess of a year (compared with just 44.5% in January 2014). By May (just before the RBNZ started cutting rates again) some 62.5% of fixed rate mortgages were for terms in excess of a year. However, as of October that figure had dropped very swiftly to just 55.8%. Over the same period the proportion of fixed mortgages for under a year swelled from 37.5% (in May) to 44.2% (October).
This would suggest to me that canny customers, while keen to lock in fixed rates that are lower than floating rates, are also keen to see what direction interest rates take in the next 12 months before committing themselves to somewhat longer terms. It is worth noting though that though still small, the amounts of money committed on terms of greater than four years have continued to increase throughout the year and the $4.5 billion worth of mortgages on such terms is more than double the amount on such terms as of January. This would suggest that some people, whatever happens to rates in the next 12 months, have found a longer term deal and a sense of certainty that suits them.
The year ahead?
Which is all great. But what of the next 12 months?
At the moment the presumption is that our Reserve Bank intends just one more rate cut (and it might not do that if it feels it doesn’t need to). If that were to be the case interest rates might have gone as low as they are going to here.
But of course the RBNZ’s made what many economists are regarding as some pretty heroic assumptions about the impact of the lower dollar on inflation in the first half of next year. The key point on such assumptions is the ability of those importing goods and services at higher prices to then pass-on those increases costs to the end user.
The world has changed. The consumer’s never had greater flexibility about how they buy things. The blissfully simple old philosophy of “it cost me 20% more to buy these so it will cost the customers 20% more” is not so blissfully simple any more. It is only one example, but I was interested in the comments of large retailer Hallenstein Glasson in a trading update last week, when it said: “The impact of a weaker New Zealand and Australian dollar is beginning to exert margin pressure and the ability to raise prices to compensate is limited.”
The Reserve Bank is under pressure to deliver on its 2% inflation target and if it doesn’t by the middle of the next year then I suspect we may well see some movement from the Government. Whether, as the likes of the NZIER have been suggesting this week, it is time to look at new targets for monetary policy is likely to become a hot topic of conversation.
That’s the pressures at home. The other key factor in determining what happens with interest rates will be offshore developments. At the moment Europe and the US are heading in different directions it seems, one down, one up. Which direction will win out? For all the current intentions being displayed in the US, I still have a nagging feeling that it too might eventually be undermined by the simple lack of inflation particularly if commodities (and oil as ever would be key) don’t pick up meaningfully. I still think there’s a reasonable chance the Fed’s attempts to ‘normalise’ interest rates may (for the next 12 months anyway) begin and end with a December rate rise. One and done, as they say.
So, this probably all leaves our Reserve Bank looking like the meat in a global sandwich. I doubt it is going to hit its inflation targets next year. The question then will be what anybody wants to do about that. If the Government’s restlessness over the failure so far of the RBNZ to get within cooee of the inflation targets translates into a desire for quick action then, independent or not, we may see the RBNZ pressured into lowering rates further. Or maybe the rules will be changed and inflation will cease to be the be-all-and-end-all of monetary policy.
It all seems to stack up for a very turbulent 12 months ahead – and yet at the end of which interest rates are likely to be largely the same as they are now.