By Bernard Hickey
The Reserve Bank has held off hiking the Official Cash Rate for the first time in four years, but has warned it expects to start increasing interest rates to "more normal" levels "soon."
This is the 23rd consecutive decision to hold the OCR at a record low 2.5%. Three out of 15 economists surveyed had expected the Reserve Bank to start tightening monetary policy with a 0.25% hike today, but the rest were forecasting the beginning of the next rate cycle on March 13 when the Reserve Bank releases its next full Monetary Policy Statement.
The New Zealand dollar dropped almost a cent in the first 20 minutes after the announcement to around 81.8 USc, but bounced a little to 82.1 USc by late morning. The wholesale two year 'swaps' interest rate, which is a base for two year mortgage rates, fell five basis points.
Governor Graeme Wheeler said headline inflation had been moderate, but was expected to increase over the next two years.
"In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon," Wheeler said.
"The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point," he said.
"The scale and speed of the rise in the OCR will depend on future economic indicators."
Wheeler said in his full December Quarter Monetary Policy Statement (MPS) news conference that he expected the bank would increase the OCR by 2.25% by early 2016. Advertised fixed mortgage rates have risen around 50 basis points on average since early December as financial markets expect the OCR to be increased by 1.25 percentage points in calendar 2014.
The Reserve Bank has never said at what level 'normal' interest rates might be, although Deputy Governor John McDermott said in a speech in October last year that the 'neutral' was around 4.5% for the 90 day bill rate, which is where the bank forecast the OCR would rise to by early 2016.
Economist reaction
ASB Chief Economist Nick Tuffley said a March hike of 25 basis points was now a "near certainty, certainty – barring an external shock or a marked and sudden deterioration in New Zealand’s prospects." He expected 25 basis point increases in March, June and December of this year, followed by similar sized hikes in March, September and December of next year to lift the OCR to 4%, which was a more gradual tightening cycle than the consensus.
Tuffley cited a higher New Zealand dollar track than the Reserve Bank expected. "We also anticipate a higher degree of debt and interest rate sensitivity than in past tightening cycles," he said.
Westpac Chief Economist Dominick Stephens said the statement "gave the impression that the RBNZ is now considering a more aggressive hiking cycle than it signalled six weeks ago in the December MPS."
"Extremely bullish words were chosen to describe the current state of and outlook for economic activity in New Zealand. The RBNZ sounded significantly more concerned about inflation pressures, particularly with the comment: 'Construction costs are increasing and risk feeding through to broader costs in the economy'," Stephens said. He is forecasting five 25 basis point hikes in 2014 and a peak of 5.5% in 2016.
"All up, the RBNZ seems to be a central bank calmly preparing for a well-signalled and steady series of OCR hikes. Yes, the total size of the hiking cycle will be slightly larger than previously signalled. But there were no signs of panic in this press release."
HSBC Australia and NZ Chief Economist Paul Bloxham, who had predicted a rate hike today, said the Reserve Bank had been "spooked" by the high New Zealand dollar.
"The central bank was noticeably more upbeat on the outlook for domestic activity. However, their concern over the high NZD seems to have held them back from hiking rates today. Instead, the RBNZ significantly bolstered their tightening bias, flagging that interest rate rises would be needed and noting that they expect 'to start this adjustment soon’," Bloxham said, adding a hike was likely in March.
ANZ Chief Economist Cameron Bagrie, who had called for a rate hike today, said he now expected the Reserve Bank to increase the OCR by 75 basis points over the first half of 2014. There are three decisions due by June 12. He then expected a 'Lange-style cup of tea' before a resumption of the tightening cycle towards a more normal level of 4.5% by 2016.
"We expect the economy to show a response to 3 hikes but this is tomorrow’s story and we expect data to print very strongly over the coming months which will keep the market biased towards policy stimulus being withdrawn in a steady fashion for now," he said.
BNZ Economist Craig Ebert said the bank had beefed up its hawkish rhetoric.
"If the “scale and speed of the rise in the OCR will depend on future economic indicators” we suggest it won’t be long before the RBNZ gets a hurry up from the data," he said.
TD Securities Economist Annette Beacher said she had expected the Reserve Bank to explain its reasons for an imminent hike, but not actually pull the trigger today. She suggested the bank may not have wanted to have put itself into the camp with emerging market central banks such as Turkey and South Africa, that have had to sharply increase their interest rates this week to defend their currencies.
"These issues are not the concern of the RBNZ, but strong growth and rising inflation are," Beacher said, adding the statement was as hawkish as expected.
Political reaction
Labour Leader David Cunliffe National's response to skyrocketing house prices and rising rents had been inept and higher interest rates would heap more pain on homeowners, renters and first home buyers.
“National has repeatedly claimed credit for low interest rates. They now have to take responsibility for looming rate hikes," Cunliffe said.
“Interest rate rises will also push up the already high exchange rate, creating obstacles for our exporters, dampening business expansion and slowing job creation," he said, adding it would widen inequality.
Green Co-Leader Russel Norman said the imminent rate hike demonstrated the Government's failure to rebalance the economy.
“Once again, New Zealand’s economic recovery is betraying the same underlying structural weaknesses of the last recovery; National has materially failed to rebalance our economy away from borrowing and consumption towards savings, investment, and exports," Norman said.
“New Zealand is enjoying the highest terms-of-trade since 1973 yet we’re still running the third highest current account deficit in the developed world. If this is as good as it gets, we haven’t made the kinds of changes needed to secure our long-term prosperity," he said.
"National’s failure to address the Auckland housing shortage with a mixture of demand and supply-side measures are forcing the Reserve Bank to hike rates, hurting the real economy."
Parsing the statement
The Reserve Bank's statement with its decision was the usual four to five paragraphs issued between full quarterly MPSes, although the MPSes also include a policy assessment that is comparable with the four to five paragraph summary.
Here's my paragraph-by-paragraph comparison of today's statement with the December assessment (in quoted form) to see how the bank's view and comments have changed.
January 30 statement
"The Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent.
"New Zealand’s economic expansion has considerable momentum. Prices for New Zealand’s export commodities remain very high, especially for dairy products. Consumer and business confidence are strong and the rapid rise in net inward migration over the past year has added to consumption and housing demand. Construction activity is being lifted by the Canterbury rebuild and by work in Auckland to address the housing shortage. Continued fiscal consolidation will partly offset the strength in demand. GDP grew by 3.5 percent in the year to September, and growth is expected to continue around this rate over the coming year."
December MPS
The Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent. Growth remains moderate but mixed for New Zealand’s main trading partners. Nevertheless, export prices for New Zealand’s main commodities, and especially dairy produce, have continued to increase. New Zealand’s GDP is estimated to have grown at over 3 percent in the year to the September quarter and the expansion in the economy has considerable momentum. New Zealand’s terms of trade are at a 40-year high, household spending is rising and construction activity is being lifted by the Canterbury rebuild and the response to the housing shortage in Auckland. Continued fiscal consolidation and the high exchange rate will partly offset the strength in domestic demand. The high exchange rate is a particular headwind for the tradables sector and the Bank does not believe it is sustainable in the long run.
The differences here are around the speed of the economic growth, which the bank still says has "considerable momentum." The bank is pointing out GDP grew 3.5% in the year to September and is expected to continue growing at a similar rate over 2014, which was more than the bank's December estimate of 3%. It has pointed to the rapid rise in net inward migration boosting consumption and housing demand, although it talked about that elsewhere in last month's statement.
January 30
"While agricultural export prices are expected to come off their peak levels, overall export demand should benefit from improving growth in the global economy. However, improvements in the major economies have required exceptional monetary accommodation and there remains uncertainty about the timing of withdrawal of this stimulus and its effects, especially on emerging market economies."
This is a newish section in the statement, emphasizing some of the emerging markets and financial drama of the last couple of weeks. Back in December markets were much calmer. It also forecasts again the Reserve Bank expects export prices to recede from their peaks, as it did last time, although they haven't receded much since then.
January 30
Annual CPI inflation was 1.6 percent in 2013, and forward-looking measures of firms’ pricing intentions have been rising. Construction costs are increasing and risk feeding through to broader costs in the economy. At the same time, there appears to have been some moderation in the housing market in recent months. The high exchange rate continues to dampen inflation in the traded goods sector, but the Bank does not believe the current level of the exchange rate is sustainable in the long run.
December MPS
House price inflation is high in Auckland and other regions due to the housing shortage, and demand pressures associated with low interest rates and rising net inward migration. Restrictions on high loan-to-value mortgage lending, introduced in October, should help slow house price inflation. Data to date are limited on the effects of these restrictions. We will continue to monitor outcomes in the housing market closely. Annual CPI inflation increased to 1.4 percent in the September quarter and inflation pressures are projected to increase. The extent and timing of such pressures will depend largely on movements in the exchange rate, changes in commodity prices, and the degree to which momentum in the housing market and construction activity spills over into broader cost and price pressures.
This is the section where the Reserve Bank talks about house prices and inflation. Back in December the bank specifically mentioned high house price inflation in Auckland. This time around the bank hasn't singled out Auckland, but has noted a moderation in the housing market in recent months. The bank repeated that it did not think the high exchange rate was sustainable in the long run.
January 30
"While headline inflation has been moderate, inflationary pressures are expected to increase over the next two years. In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon. The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point. The scale and speed of the rise in the OCR will depend on future economic indicators."
December MPS
The Bank will increase the OCR as needed in order to keep future average inflation near the 2 percent target midpoint”
This is the business end of the statement. It indicates the bank's thinking on interest rates. In this statement the bank has emphasized the need to start increasing interest rates to more normal levels "soon."
The talk of 'more-normal' levels isn't that unusual. The bank has talked about it in the past but the use of the 'normal' phrase in the state has placed a greater emphasis on it. The bank has cleverly given itself some wiggle room with the use of the word 'soon' and the comment about the scale and speed being dependent on economic indicators.
Most economists think 'soon' means March 13. We'll find out a lot more about the Reserve Bank's thinking and a fresh set of forecasts then.
(Updated with currency move, economist reaction, political reaction)
33 Comments
"The Mortgage Storm" we were were warned about feels more like a bit of dappled sunlight breaking through some whispy clouds.
If the RB wants to increase the OCR "soon" then get it over with now instead of tip- toeing around it.
Nothing is worse for the market than uncertainty.
But the RBNZ did pretty much as expected by the market which had only 30-40% chance of a hike priced in, and 12 out of 15 economist said March, not Feb. NZD down 80 odd points showing a few got long in anticipation, but now correcting, and swap rates down 5-6bos points as the Jan rate hike is priced out. So all very modest move by the market as all going to expectations currently, and Wheeler basically said March as clearly as he possibly could. I don't care what we think should happen , I only care about what will happen, and barring an "event" between now and 13 March, that will be the date.
Perhaps the market is positioning for deflation
Big Daddy - Yes. Certainty is good. But in my opinion the RB bank does a very good job in trying to be predictable. Within the limits imposed by others.
There does seem to be a problem is that the thursday announcement every few weeks seems to be surrounded by a media circus that makes 'the announcement' into something like armageddon. Drumrolls included. 'Storms' etc.
We see 'sampling' of economists as to what the result might be, as Grant points out. Overcooked and not much point in my view. And endless waffling and speculation. TV news last night was warning home buyers. Doh.
if somebody is trying to make a buck speculating on currency or interest rates using hundreths of a percentage point maybe the verbage would be fascinating.
But if you are about to get that mortgage for a house, then it's enough to hear about it later, without the pre verbage. Do you even need to know the RB exists.
Here's a statement from bank lobby group the NZ Bankers' Association;
Get set for rising interest rates
Now is a good time to prepare for rising mortgage interest rates said the New Zealand Bankers’ Association in response to the Reserve Bank of New Zealand’s Official Cash Rate statement today.
While the OCR has been left unchanged at 2.5%, the Reserve Bank has recently projected the cash rate could rise by 2.25% over the next two years.
“Mortgagors have enjoyed historically low interest rates for over two years. The cycle is now turning with some interest rates starting to rise,” New Zealand Bankers’ Association chief executive Kirk Hope said.
The OCR will continue to be an important driver of interest rate changes, but there are other factors that influence the level of the rate change including the cost of funding from domestic deposits and the cost overseas wholesale funding.
“Now’s the time to assess your circumstances and get your finances in order so you can manage an increase in the cost of borrowing. This is especially important for first home-owners who have borrowed at very low rates.”
“Talk to your bank if you have any concerns. Banks are happy to provide information about products and services to suit individual needs.
“On the flipside, the projected rise in interest rates is good news for people with term deposits. People who rely on interest income from investments, especially retirees, haven’t done so well recently. They stand to benefit from rising deposit rates,” added Hope.
Hey DFTBA, we're doing three things. To explain, I'll use some rough figures.
Our loan is for 25 years. We're one year into it, so 24 years to go. Fortnightly repayments are, say, $1000 per fortnight.
1. I calculated that we could afford to make payments of $2000 per fortnight. The bank allows us to pay this amount. We agreed on this before the interest rate was fixed for 12 months. We're not allowed to pay more than $2000 per fortnight. But we can lower the amount, at any time during the 12 month fixed period, as long as we meet the minimum repayments of $1000 per fortnight as per the original schedule. The term of the loan is still 25 years. Obviously, if the higher payments continue, we will be done with the loan well before 25 years. We're aiming for about 5 years.
2. We have a small portion of the loan (about $10K) on a discounted floating rate. We also have the ability to withdraw another $30 K from this account and pay only the discounted floating rate. I am quite impressed with the flexibility of this arrangement to help with uneven cash flow that we may experience. My wife does contract work and has a big tax bill coming up. We might dip into the $30 K overdraft to pay that. This flexibility of this arrangement is quite good for us when our incomes are not completely predictable.
3. The fixed rate is only for 12 months. If we've accumulated some extra cash by this time next year, we can make a lump sum payment when the fixed term expires and before refixing again.
We're with one of the major banks. I found them quite helpful and flexible in coming up with something specific to suit us.
Impressive organisation there pythag...
You have obviously thought your circumstances through.
And good to see someone else on this site stating that the bank was good to work with. I find that to be the case almost all the time in my business dealings with banks too.
Thanks Pythagoras - that does explain it well, and it is quite unusual for a bank to allow you to double your repayments for a year - I assume they've calculated that an extra 12k won't breach their own 5% rule.
Flexi accounts or revolving credit accounts are, indeed, a very handy tool if you have uneven cash flows.
.
The 5% max is common on fixed accounts.
Paying extra is good, after all you've already paid the rent for the money for the year, so any extra principal paid now is good (it reduces next years moneyrent)
Be careful the bank doesn't let you pay off faster than the 5% then ping you for the fast repayment cost.
Floating rate accounts can be paid down at any rate (normally). So pay your 5% off the fixed, and then the rest off you floating.
Interest only is usual floating or short term fixed.
And here's a statement from Russel Norman;
The signalled Official Cash Rate (OCR) hikes over this year highlight National’s failure to build a strong, resilient, jobs-rich economy, the Green Party said today.
The Reserve Bank Governor made his strongest hint yet of imminent OCR hikes saying that ‘the Bank expects to start this adjustment soon’ in response to inflationary pressures driven by rising house prices in Auckland and the Canterbury rebuild.
“The National Government’s failure to fix the housing crisis in Auckland is going to result in interest rate hikes hurting the whole economy,” said Green Party Co-leader Dr Russel Norman.
“Higher interest and exchange rates will effectively cost jobs, exports, and raise the cost of living for all those with mortgages.
“A possible one percent hike in the OCR will raise the average homeowner’s interest payments by $70 a fortnight.
“Wage rates are not keeping pace with inflation, so adding further costs to households will hurt.
“Once again, New Zealand’s economic recovery is betraying the same underlying structural weaknesses of the last recovery; National has materially failed to rebalance our economy away from borrowing and consumption towards savings, investment, and exports.
“New Zealand is enjoying the highest terms-of-trade since 1973 yet we’re still running the third highest current account deficit in the developed world. If this is as good as it gets, we haven’t made the kinds of changes needed to secure our long-term prosperity.
“National’s failure to address the Auckland housing shortage with a mixture of demand and supply-side measures are forcing the Reserve Bank to hike rates, hurting the real economy.
“National’s failure to introduce a comprehensive capital gains tax (excluding the family home) has meant property speculators will continue to be rewarded at the cost of the productive economy and all those seeking to buy their own home.
“Rising interest rates will mean that New Zealand will lead the OECD hiking rates presenting a huge upside risk to our exchange rate, hurting exports and jobs,” Dr Norman said.
I shake my head in wonder at Dr Norman sometimes .
Apart from an over- reaction I note that his comment is full of crticism based on unsubstantited evidence , but offers not one solution .
I wonder if there is any statistical evidence to support his wild statement that there is no saving or investment , just borrowing and consumption .
The inflationary presures are coming to a significant extent from the very thing he cites as having not been addressed;- Housing and the construction sector .
Housing development is going gangbusters , and costs are being pulled up in tandem feeding into inflation
... the M&A action in the USA is in biotechs ... and there's screeds of potential candidates listed over on the ASX , and even a handful on the NZX ....
Some will go up 10 times , even 100 baggers are possible , many( most ! ) will slop sideways for years .... and others will go to xero .... ummm , sorry , zero !
People - surely we realise the RB can have no influence over the exchg rate. Between the big money movers in Europe and further "necessary" QE by the US the $ will stay high for some time. Equally, if our economy is so "great" this will only attract further investment. Surely in that scenario banks will be able to access "cheaper" money pushing down their costs. I fell there has been a fundamental shift in consumption - Dr Norman may be right this may not be in the form of "saving" but it is a shift to debt reduction the first kind of saving - it's not as if people are getting massive pay rise, most of us are on floating loans so any disposable income goes to debt instead of TV's, holidays and new cars - who's getting HP's nowadays? 50 month interest free regardless??
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