Interest rates not just rising in New Zealand

Interest rates not just rising in New Zealand

Glove holding American $20 bills in front of USA flag

In the United States this week we have seen the Federal Reserve Board raise their key interest rate by 0.25% with a target range now of 0.25% to 0.5%. They also signalled a very strong intention to raise interest rates many more times this year with the aim of getting the rate just below 3% in 2023.

By historical standards this does not sound high.

But US interest rates have been at extremely low levels since 2009 with persistently low inflation following the Global Financial Crisis making a return of this key rate to more reasonable levels impossible.

In New Zealand our central bank at least tried two times to take away record low rates in 2010 and 2014. But both times they had to cut rates quickly and kept cutting in 2019 then again in 2020 until our cash rate sat at a record low of 0.25%.

The rate is now 1.0% and my expectation remains that it will peak at 3.0% sometime next year.

Then, after a period at that level, it will probably fall a bit come 2024-25. This is the same expectation for monetary policy as the financial markets have built in for the United States and it bears recognising that just because rates go up does not mean that they never come down again.

Eventually, higher interest rates curtail inflation and the need for restrictive conditions disappears. That is why the wise interest rate hedging recommendation I made from mid-2020 to mid-2021 of fixing for five years is not something you hear now.

In fact given a good chance of mortgage rates falling maybe from late-2024, fixing longer than three years is perhaps too cautious an approach. Then again, the world we live in is full of surprises and we have all proven that we can’t really forecast what inflation is going to do. It might continue to surprise on the high side in coming years. Or it might fall away.

It pays to remember that in New Zealand from 2012 – 2019 inflation averaged an unusually low 1.2%. The latest rate of 5.9% and likely peak soon near 7.5% are therefore aberrations in the context of what inflation started to do after the GFC and with internet technology giving great power to consumers.

The next review of monetary policy in New Zealand happens on April 13.

At that review the Reserve Bank is likely to raise the cash rate at least 0.25% and maybe by 0.5%. When it is clear that interest rates need to be much higher a central bank is incentivised to get rates there as quickly as possible.

If and when we get rates rising 0.5% you will see some scary headlines and some predictions of the likes of floating mortgage rates going above 7%. But my view is that the peak for floating mortgage rates will be close to 6.5% and there will be very few borrowers who did not have to prove their ability to pay at least a 6.5% rate when their bank gave them their mortgage in the past few years.

So, while cash flow pain will come for many and we will see cutbacks in spending on travel, hospitality, couches, cars, and spas, in the housing market a rout is very unlikely. The price correction from unsustainably high levels reached late in 2021 will probably continue for most of this year and produce falls adding up to close to 10%.

When we allow for high inflation that will mean real house prices end up falling close to 20% which is about half of the decline between 1975 and 1982. But it will happen in a shorter period of time and that is partly why some challenges are going to arise for the residential construction sector over the next couple of years.

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