GRA Blogs

Articles by The Professional Trustee Team

The Professional Trustee Team

Dollars, sense and interest rates

2998

The general consensus of opinion is interest rates are on the way down but the big questions still remain: when will the cuts come and how low will the rates go? 

BACKGROUND

On 10 September 2015 the Reserve Bank of New Zealand (RBNZ) cut the Official Cash Rate (OCR) from 3% to 2.75%.  For many people, this was a surprising move.  Previously the RBNZ had aired concerns that a dip in the sizzling hot Auckland property market could affect the stability of our financial system.  

Cuts to the OCR tend to mean banks reduce their floating and short-term interest rates, thereby enticing customers to borrow additional funds, applied primarily towards the purchase of real estate.  Accordingly, reducing the OCR seemed contrary to the RBNZ's policy aim.  Then again, our dollar was relatively high, hurting our exporters and contributing to the weak economic conditions the rest of New Zealand was experiencing.   Ultimately, it seems the RBNZ actions were an attempt at bolstering up the nationwide economy even though it knew it would be adding fuel to the Auckland property market.  Perhaps it reasoned the new loan-to-value restrictions and the measures the Government intended on taking, such as the introduction of the Bright-Line Test, would reduce the heat the real estate market was experiencing.

Which brings us to the new chapter.  The forthcoming review date for the OCR is scheduled for 29 October 2015.  Will another cut be made or will the RBNZ pause at this point in the cycle?

NEXT OCR DATE
It's no secret dairy prices have lifted through September and October.  All good news for our economy.  But against this it has to be acknowledged our dollar has bounced sharply over and above prior estimates made, which doesn't help our exporters or our nationwide economy one little bit.  Additionally, playing heavily on the RBNZ Governor's mind will be the fact that the new measures recently taken have had little effect on the Auckland housing market, where prices have continued to rise.  As noted above, a decrease to the OCR is likely to have an effect akin to adding further fuel to a bush fire.

Placing emphasis on the recent upbeat economic news and taking all of the above into consideration, I expect the Governor will hold his hand in October.  He may well do this on the basis he'll need some additional ammunition in his gun if global conditions deteriorate further and inflation back home doesn't respond upwards.  Delaying cuts will give him some firing power if he needs it.

A decrease to the OCR I purport will occur on 10 December 2015.  Unfortunately, at that time our Governor will not have the benefit of knowing what the USA Fed are intending to do when their review date occurs on 17 December.  They may take no action.  After all they have been threatening to tighten for the last year at the very least. Then again they may act, and if they do, we could expect our dollar to lose strength, helping our exporters and increasing economic growth and inflation.  This is based on some large assumptions:  the USD does actually lift to anticipated levels and export orders do still keep rolling in.  Both assumptions are big ifs.  Just because the USD gains in strength does not mean the NZD will drop dramatically; after all we're strong against several other currencies.  Furthermore, who knows what inventory levels China has and what they will need going forward as they attempt to turn their economy into consumption mode.  It's also anyone's guess what effect this will have on America and what run-on effects NZ will feel.  That aside, by 17 December the OCR may have been cut and this may well turn out to be a bit premature if the Feds have engaged in a tightening round.

Then again, we are expecting low inflation in 2016, which could force more than one cut to the OCR as the RBNZ attempts to stimulate inflation towards its target on a sustained basis.  At present, the RBNZ is forecasting inflation will return to the midpoint of its target range of 2% by the middle of 2016 but this forecast is heavily reliant upon a lower New Zealand dollar on a trade weighted index basis.  The RBNZ forecast has already come unstuck in this respect because of the recent increase in our dollar.  What do I think this means?  Probably that the RBNZ will have to decrease the OCR several times. Hence in addition to the cut I think the Governor will make in December, I think decreases to the OCR could occur in March and June 2016 until the desired inflationary target is achieved and held.

EFFECTIVENESS OF OCR DECREASES
Cuts to the OCR are premised on the assumption effects will flow through, driving interest rates low, inciting borrowing, production and buying, culminating in a boost to inflation, which we all know has stubbornly remained low globally and in New Zealand.  

This in turn is based on a belief tended to be held by central bankers, that the type of inflation the world has recently experienced is cyclical in nature.   But if this is the case, why haven't the actions the central banks have engaged in, such as taking steps to ensure internal interest rates fall and remain low (or non-existent) and printing an eye-watering amount of money, not boosted economies' strengths?  

The above measures certainly don't appear to have fixed inflation issues. Sure America's employment market has increased, but its share markets are weak, businesses are refusing to open their wallets and consumer spending has been reined in considerably.  China has fared no better. House prices have fallen, share markets are fragile and a cultural consumption orientation has not occurred despite being actively encouraged.  Europe hasn't escaped either.  Debt levels remain high and rising, and confidence has been lost internally and globally.  Ultimately, economies and inflation haven't grown despite central banks' measures.  Could it be because inflation is structural rather than cyclical and old measures no longer work in a new world?  

If inflation is structural, the steps central banks have taken will be of little avail.  This is simply because price increases will not be permitted to occur, hence economies and inflation won't grow.  Unpicking it, if inflation is structural, it means it is linked to changes in technology, globalisation of products and services, and aging populations.  Globalisation and the use of technology will have the effect of lowering prices on goods and services produced and offered, consumers will purchase same based on price alone, and firms will be unable to raise prices.  Thus, despite the savings made in cost of production, firms will not be able to make further margin.  This means economies won't grow, even if large amounts of product/services are sold to consumers, hence inflation won't occur.  Ultimately, if this is the case as financial markets believe it to be, interest rates could remain low for a very long period of time yet.

TIMING OF POSSIBLE OCR CUTS
This all leads us back to the timing of cuts to the OCR.  The RBNZ is between a rock and a hard place.  

A scenario that could be played out is the RBNZ could continue to cut the OCR in an attempt to lift the economy nationwide.  At the same time, this action will undoubtedly throw gasoline on the Auckland property market. We already have evidence of this.  Banks are currently permitted to lend 10% of their new lending book to people outside their existing LVR rules. This is referred to as the LVR speed limit rule.  This has simply pushed investors to purchase outside of Auckland where the speed limit on a bank's lending is 15% and investors can borrow at a 20% LVR.  Hence, regional prices have been pushed up.  Overall however, demand for housing has not decreased.  The problem has simply been shifted to the regions.  Does this mean the RBNZ will in the future increase the LVR to 30% across NZ or will it entertain the use of other tools such as income-to-debt ratios in an attempt to mitigate the effect a decrease in residential real estate values could bring about in the financial stability of our system?  This isn't too far-fetched.  It certainly has occurred in Ireland.

An alternative state of affairs, albeit a highly unlikely scenario in my opinion, is the RBNZ could choose to control the Auckland property market and indeed the rest of the residential markets operating in New Zealand, by not decreasing the OCR.  This will ultimately mean its inflationary targets will not be achieved and the nationwide economy will suffer further.

My pick is the RBNZ will put New Zealand's interests first.  It will decrease the OCR to 2.5% by the end of the year, probably seeking December to make its cut.  Further cuts I think will occur in March and June 2016 as the RB Governor is forced to act to stimulate the economy towards target.

Of course this time prediction is based on a couple of assumptions:  the El Nino drought does have an impact upon agricultural production, the house market does slow due to the measures taken by the RBNZ and the Government, and inflation is found to be running closer to 1% than 2% for much of 2016.

If of course these OCR cuts do occur, we can expect a reduction in the current interest rates, as such cuts haven't been fully priced into these rates yet.  Possibly fixed mortgage rates will fall below 4%.  

Then again, I could be completely and utterly wrong!

The Professional Trustee Team
signed
The Professional Trustee Team
© Gilligan Rowe & Associates LP

Did you like this article? Subscribe to our newsletter to receive tips, updates and useful information to help you protect your assets and grow your net worth. We're expert accountants providing expert advice to clients in NZ and around the world.

Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.
Comments

Add a Comment

Log in or sign up to post a comment

Testimonials
The whole course was great. Super informative. - David M - June 2017
logo

Seminars and workshops for property investors, business owners and anyone seeking to create and protect their wealth.

View all our upcoming events
Learn More

Property 101by

Investing in residential property?

Put this at the top of your reading list.



If you're investing in residential property, seeking to maximise your ability to succeed and minimise risk, then this is a 'must read'.

Matthew Gilligan provides a fresh look at residential property investment from an experienced investor’s viewpoint. Written in easy to understand language and including many case studies, Matthew explains the ins and outs of successful property investment.

  • How to find the right property
  • How to negotiate successfully
  • Renovation do's & don'ts
  •  Property management 
  • Case studies and examples
  • and much, much more...
TOP