By Bernard Hickey
Finally.
After nearly three years of stable, record-low interest rates and warnings of future hikes, the Reserve Bank has finally done it.
The central bank announced a 0.25% increase in the Official Cash Rate (OCR) to 2.75% in releasing its March Quarter Monetary Policy Statement. It also forecast short-term interest rates would rise around 2.5% by early 2017 as it noted building inflation pressures.
The bank also slightly raised and front-loaded its forecast for interest rate hikes this year, assuming around 1.25% of hikes before the end of 2014 and a further 1% of hikes in 2015. Governor Graeme Wheeler said the 125 basis points this year was slightly above the market expectations for 110 basis points of increases.
The increase was in line with expectations, but the higher interest rate track forecast signals a more hawkish view by the bank. The New Zealand dollar rose almost a cent to 85.6 USc, which lifted the Trade Weighted Index to a fresh record high of close to 80.
Meanwhile, the bank also noted the recent surge in migration as a factor boosting the economy and inflationary pressures, particularly in the housing sector.
However, it also reported its speed limit on high Loan to Value Ratio (LVR) loans was moderating house price inflation and the impact had been more front-loaded than it expected.
Wheeler later told the news conference the bank's modelling estimated house price inflation would have been 11% now without the high LVR limit, implying it reduced house price inflation by about 2.5% to the current 8.4% rate of house price inflation.
The bank also pointed to the high New Zealand dollar as a factor driving tradeable sector prices lower, although it said its strength was not sustainable in the long run.
Market and economist reaction
The New Zealand dollar jumped around half a cent to over 85.2 USc immediately after the decision and the Reserve Bank's comments, including those from the Governor in the news conference indicating the Reserve Bank would not intervene in the currency market, despite it being unsustainably high over the long term. The currency rose further in mid-afternoon trade.
ASB Chief Economist Nick Tuffley lifted his OCR peak forecast to 4.5% from 4% after the decision and statement.
"Given the RBNZ has front-loaded its interest rate increases a little more into 2014, we now expect 4 OCR increases of 25bp each over 2014," Tuffley said, adding he saw the next three hikes in April, July and December.
"To us, factors such as the risk of further NZD appreciation and a lot of uncertainty over how households will react to OCR increases are reasons for expecting the RBNZ will not lift the OCR 3 or 4 times in immediate succession," Tuffley said.
Westpac Economists Dominick Stephens and Michael Gordon also pointed to the Reserve Bank's implied 'front-loading' of forecast rate hikes.
"That doesn’t leave much wiggle room to debate the timing of those hikes, and supports our prior view that the OCR will be increased further at the next three reviews in April, June and July, with further hikes from December onward," Stephens and Gordon said.
Parsing the statements
Here is a comparison of today's statement on monetary policy with the Reserve Bank's last statement on January 30.
March 13 - The Reserve Bank today increased the OCR by 25 basis points to 2.75 percent. New Zealand’s economic expansion has considerable momentum, and growth is becoming more broad-based. GDP is estimated to have grown by 3.3 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners. However, improvements in major economies have required exceptional support from monetary policy. Global financial conditions continue to be very accommodating, with bond yields in most advanced countries low and equity markets performing strongly.
January 30 - 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.
The difference: This time the bank noted the economic expansion now had considerable momentum and was more broad-based, whereas last time it was only "moderate but mixed".
March 13 - Prices for New Zealand’s export commodities remain very high, and especially for dairy. Domestically, the extended period of low interest rates and continued strong growth in construction sector activity have supported recovery. A rapid increase in net immigration over the past 18 months has also boosted housing and consumer demand. Confidence is very high among consumers and businesses, and hiring and investment intentions continue to increase.
Jan 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.
The difference: The Reserve Bank's focus on a surge in net migration is a new focus in the latest statement.
March 13 - Growth in demand has been absorbing spare capacity, and inflationary pressures are becoming apparent, especially in the non-tradables sector. In the tradables sector, weak import price inflation and the high exchange rate have held down inflation. The high exchange rate remains a headwind to the tradables sector. The Bank does not believe the current level of the exchange rate is sustainable in the long run.
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.
The difference: The bank focused more this time around on non-tradeable inflation, noting later in the full Monetary Policy Statement that tradeable prices would actually fall because of the high New Zealand. It left its language about the New Zealand dollar's current level being unsustainable.
March 13 - There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are starting to ease pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration flows will remain an offsetting influence. While headline inflation has been moderate, inflationary pressures are increasing and are expected to continue doing so over the next two years.
In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The Bank is commencing this adjustment today. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures. By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.
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.
The difference: This time around the bank was less specific on the types of inflationary pressures that would determine the speed of the rate
(Updated with Parsing of the statements and comments from news conference, market reaction, economist comments)
40 Comments
Done , so now what?
Its a tiny increase but :
- Will the Kiwi$ strengthen by 1 cent agaisnt the US$?
- And 2 cents agaisnt the Aussie.?
- Will the Kiwi$ increase with expectations of more?
- Will Banks increase floating mortgage rates ?
- Hire purchase and finance agreement loans ?
- What will happen with Capital intensive NZX Companies carrying debt on the balance sheets?
- Such as Mainfreight?
- Will companies be able to pass on the increase in costs?
- Will these cost increases further stoke inflation?
- Leading to more increases?
Or will it be a phony war where nothing happens for a good while ?
House price inflation is out of control and general inflation is on the up.
Wheeler knows exactly what he's doing. He's looking a year ahead and controlling the risk of rampant inflation in New Zealand's economy. You're looking no further than your increased mortgage payments.
The prosperity you enjoy now is a result of inflation-targetting interest rates since 1990. If you believe in BAU (ongoing economic growth) then this is the only proven model. If you believe in game changers (peak oil, global warming) then you have a legitimate argument against this regime.
Depends on his reasoning, which we dont get to see.
His biggest issue is the stupidity of the housung speculation, if this is him giving a warning, well its what I would do, despite the side effects.
Look at his expectations, he now says 2.5% but by 2017....that suggests slower future rises maybe the expectation.
regards
They should change the name from "The Reserve Bank Act" to "The Entrapment Act" because that is exactly what it does - it entraps people into debt.
The Reserve Bank lowers interest rates then waits to see how many people get into debt. If not enough people get into debt they lower the rates further and keep doing this until enough people are in debt. Then they say "Gotya" and put up the interest rates and screw their lives up.
Can anyone out there name a time in history when the Reserve bank put up interest rates when debt was falling?
No they always do it when sufficient people have taken on debt.
This is the most disgusting piece of legislation and should be scrapped. And anyone who supports it are just as bad. Shame on you.
That is my oppinion
Kiwimm
You are assuming, or of the opinion, that the only way to stop "exacerbrating future problems" is by raising interest rates.
As you have seen with LVR's it has put a dampener on house purchases.
LVR is a form of bank reserve restriction.
Bank reserve restrictions, on all loans, would stop inflation and not hurt first home buyers who already have a mortgage.
Inflation is caused by excess demand (money). Raising interest rates reduces demand. But raising bank reserves also reduces demand.
The simple solution is not to take on debt when rates are low (espscially true when they are at a record low). It is doubly bad as people will inflate asset prices at times of low interest rates as the valuations are based on short-term affordability. So you buy high, your costs increase as the rate increases and you asset devalues.
Unfortunately, people have a bias to recent data and also a bias to extrapolate the current. So as there hasn't been a serious rate rise since 2007, they have been buying "with their earrs pinned back". Caveat emptor.
As an example of the deflationary power of rising interest rates: consider a young, Auckland couple who buy a $600,000 house with 20% deposit. They have a mortgage of $480k on a 30 year term at 6%, this would cost $3,093 per month. If rates rise to 8% then a similar couple who can only take on a mortgage of $401k to keep the payment the same.
This is, in effect, a reduction of $79k or 16.5% of the house price. But don't worry, I'm sure those cashed up foreigners will want to buy into a falling house market.
Kiwimm
You are correct people should not take on debt when rates are low however we live in the real world.
We have laws to wear safety belts so we dont get hurt in a car accident.
We have cycle helmet laws so we do not get brain damage if we come off our bikes.
We have swimming pool fencing laws so our children do not drown
We have many laws to force people to take care of themselves.
When it comes to banks and mortgages then people can go to hell and who cares if they drown in debt
Double standards anyone
Ivan I don't think that is quite correct.
As a depositor where do you think your money is sitting?
Do you understand what bank reserves are?
Most of the money on a mortgage only exists on paper it is a computer click and it magically appears. There is no physical cash that actually backs most if not all of the mortgage.
A mortgage is really a trust thing. The bank trusts that the person who takes out the mortgage will pay the amount back over the life of the mortgage.
Should this money that is created out of thin air actually have any interest charged on it?
If a depositors funds are used then yes they should receive interest at a market rate and I have no problem with that. But I have a problem with interest being charged on money that is not really in existence until the mortgage holder makes a principle payment.
It doesn't matter whether you are a depositor or a mortgage holder you are being screwed and people need to understand this. This is a system problem.
Putting up interest rates is just another way of helping the monylenders cream up some more profits.
Consider this
If total debt is $100 billion and the average interest rate across that debt is 6% then the monylenders make $6 billion in interest payments.
Now, they keep putting up interest rates until the average interest rate is 10%. But total debt falls by 40% to $60 billion. The moneylenders are still making $6 billion in interest payments (10% of $60 billion). But they now have $40 billion not used.
When interest rates rise, equity and property prices fall. Hey presto, the moneylenders move in and buy cheep equities and propoerty.
Then they lower the interest rates and their equities and property go up in value so the monylenders make anothe killing.
Inequality anyone?
You should probably add in the cost side. If we assume the bank makes a 2% net margin at all interest rates it looks like this:
$100 billion @ 2% net = $2 billion
$60 billion @ 2% net = $1.2 billion
The return on investment is still 2% but the profit is reduced in dollar terms. The road to bank profits is not littered with shrinking loan books.
Ha.
It's started already.
A few percent increase in interest rates from historic lows and people are already talking depression !
Shows how stretched some are.
Most households are either mortgage free or have very small morgtages.
A lot of mortgages are mid-long term fixed, and that is accelerating.
Mortgagee sales will be picked up by the cash rich.
A transfer of wealth from the over-indebted.
Happens EVERY cycle.
Property investors are not buying in auckland as its already too stretched. They should be looking at defensive investments, areas that have not had the increase in value that auckland has had and will be the next to see the value lift; high yielding growth centers that have exposure to dairy farming, taranaki and manawatu look good value, p.n is growing and has a worse housing shortage than auckland, central welly apartments that are not leaky or earthquake prone are good value (extreme shortage here with no new builds near cbd proper in pipeline) and will benefit when labour eventually get back into power (3.5 years time?) and start growing public sector again.
And most serious property investors who have been around a long time (which is the majority) have large established auckland portfolios, and may have added prehaps 10% or less by value to them with the odd purchase in last few years. But the biggest difference between them a few years ago and today is around 30% increase in equity, and with it a large reduction in their leverage ratio (as debt stays the same and equity rises). While at the start of the property cycle, the cash to stimulate price increases may well have come from offshore, at this point, after initial rises of around 30% in auckland, the cashed up people looking to buy property are actually local property investors. And these investors, believe it or not, value assets based on fundamentals, i.e the revenue they produce (yield). Hence why at this point in the cycle we see investment spread outside of auckland and into higher yielding cities. Watch for it to happen again over the next couple of years, as the OCR rises.
No stupid comments from SK today. Pretty hard for SK to do that when this is just the start of several increases. Those who will be hurt most will be the silly FH Buyers who wanted to live like their parents first time up and borrowed big time to do it. They were not prepared to work their way up. Man have us baby boomers spoilt our kids.
Gordon maybe you would like to elaborate on your theme
"silly FH Buyers who wanted to live like their parents first time up and borrowed big time to do it. They were not prepared to work their way up. Man have us baby boomers spoilt our kids."
Over here The net effect of NZ's where I show how hard working renters who haven't even got to the FH status are being screwed.
There was evidence of FHB in Auckland borrowing around $800k to live in nice leafy areas like mum and dad. My niece did exactly that but sold last year as she worked out she was simply working in a stressful job to keep her landlord " the bank" at bay. She and her husband were finding they did not have much left to live on after paying their interest. They now live in a do up a bit farther out but are much happier . I think it put stress on their relationship . The high payments that is.
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