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.
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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
2 Comments
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.
Hmmmmm...
In fact, the futures market, which is what really matters, is re-enacting the same behavior as in 2014. Each of these BOND ROUTS!!! following each major “reflation” selloff occur with less and less futures market conviction.
In this latest one, the center of gravity barely shifted to net long, and it did so starting the week of September 5 – when everything else in dollars and “dollars” went nuts. That would seem to indicate a more cautious tone about the market than a significant change in stance. Read more
What do low low interest rates actually achieve?
I am in business, low rates have a zero or negative effect, rents are based on the value of the property, so low interest rates create higher rents, rather than lower.
Our company saves earnings, so our stock is funded from retained earnings, no benefit there for us.
Fixed charges such as rates, water, phone, power, insurance have increased significantly, so no benefit from that quarter either.
My kids pay more in weekly payments than when homes were lower priced and interest rates higher. I think due to those with cash (and or a willingness to take on historically high debt levels) place money into property. Despite the rhetoric, beating the low returns curve fixed interest offer.
So no benefit from that quarter.
In some industry and business low interest rates, immigration trickery, (sponsoring rorts, under payment etc) has resulted in intense eye wateringly fierce competition, compounding the low wage economy we now have. That is apart from Council - no hint of a competitive behaviour there.
Debt at 160 % plus of income should concern us all. Especially as that figure is population based and many many have no debt, meaning those that do are well over their heads in debt.
Japan has had low low rates for as long as I can recall now - fixed zero in that economy.
Interest rates are best set at market, like currency and housing prices as an example. I believe we need to normalise our economy.
That's my view.
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