By Roger J Kerr
Any forecast or outlook for the direction of New Zealand interest rates needs to take into account the two entirely separate and independent interest rate markets that drive the overall shape/slope of the interest rate yield curve.
Inflation trends and RBNZ responses with the OCR determine our short-term interest rates out to three years forward.
However, beyond three years the movements in interest rates do not have much to do with New Zealand and our economy/finances; the three to 10 year swap interest rates are all driven by US Treasury Bond yield movements.
Currently US 10-year Treasury Bonds are moving up as US economic data prints stronger and the Federal Reserve have stuck to their guns about increasing their short-term interest rates.
It would not be too aggressive to forecast US long-term interest rates increasing another 1.00% over the next 12 months and our three to 10 year yields correspondingly increasing by a similar amount.
The direction of our short-term interest rates is not as clear-cut in my view.
The arguments for and against significant increases in 2018 are summarised as follows:-
Scenario 1: Winston is right and we witness a significant economic slowdown
A weaker economic growth path and outlook will be reflected in consumer and business confidence levels falling away.
If this happen, business firms will be less able to pass through any cost increases with wages, currency and fuel into their selling prices i.e. inflation does not increase.
House price trends also come into the equation; a major correction downwards in house prices means that it is much less likely the RBNZ will increase interest rates that would squeeze property owners even more.
Scenario 2: Status-quo for economic growth and inflation increases
Should economic growth maintain its current pace, the probability of the RBNZ being forced to change their benign inflation outlook increases.
Current RBNZ inflation forecasts are based off a 77.50 TWI exchange rate, today it is 5.5% lower at 73.13.
Tradable inflation will increase from both the currency impact and higher oil prices.
Business firms will be more confident about achieving price increases to compensate for their higher wages costs.
Construction and food prices continue to increase for their own unique supply/demand reasons.
Under this scenario the annual inflation rate will be above 2.00% through 2018, not 1.00% as the RBNZ currently forecast.
In their current mood the RBNZ will want to see actual higher inflation for a couple of quarters before changing their monetary policy stance.
However, they may well be behind the inflation eight-ball by mid-2018 adopting this approach and be forced to tighten harder.
Despite what Finance Minister Grant Robertson states about a dual RBNZ mandate with employment objectives potentially keeping interest rates lower, I doubt that any new Policy Targets Agreement with the RBNZ will change the future interest rate track.
Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com