OCR remains unchanged, RBNZ to keep monetary policy steady

Straight road lined with trees

The Reserve Bank this week undertook its first review of the state of the economy and its official cash rate since November last year. It was universally expected that there would be no change in monetary policy and the Reserve Bank spent over 50 pages stressing that much as the economy is doing well, they see no scope for tightening policy at this stage.

The underlying position for the Reserve Bank with regard to interest rates can best be summed up by this quote from their report.

“The Committee reflected on the international experience of central banks following the Global Financial Crisis. The Committee agreed that it was important to be confident about the sustainability of an economic recovery before reducing monetary stimulus.”

Following the 2008-09 GFC some central banks raised their interest rates too soon – our Reserve Bank included. They took their cash rate from 2.5% to 3.0% in 2010 but cut it early in 2011 when the upturn in the economy sputtered out. The 2011 Christchurch earthquake determined the timing of the rate rise reversal, but they would have cut the cash rate back to 2.5% even without that event.

Overseas, other central banks in hindsight have been judged to have pulled back from money printing operations too soon, and in doing so locked their economies into low growth and excessively low inflation environments for a decade.

So, it was unsurprising that in this week’s report the Reserve Bank gave exactly zero hint of any timing for when they would contemplate raising interest rates.

Does this mean then that borrowers can rest easy because interest rates will probably stay low until 2024?

After all, this is exactly what central bankers have said in the past three weeks in Australia, the United States, and the UK.

No. Markets move in response to expectations and the growing expectation here in New Zealand and overseas is that central bankers are going to have to raise interest rates much earlier than they are signalling and that the longer they delay the faster the period of rate rise catch-up which will occur.

The common pick for New Zealand is that sometime next year the official cash rate will rise from 0.25%. How fast it rises is impossible to predict with any accuracy because we have no experience of how economies operate once they come out of a global pandemic, and even the GFC experience shows that without a pandemic, central banks still don’t really know how recoveries develop.

But for borrowers there are important signs which should not be ignored

Across in the United States the most closely watched interest rate – that for the ten-year US Treasury bond – has risen to just below 1.4% from 0.8% in October and a low of 0.6% in April.

In New Zealand the one-year swap rate at which banks borrow funds to lend fixed for one year, has risen 0.25% since October to sit near 0.3%. The three-year swap rate has risen 0.5%, while the five-year rate has risen by over 0.8%.

Margins for fixed rate mortgages are now well below average for the past two years, and for my personal favourite of the five-year fixed rate at 2.99%, the margin is almost at a record low.

Well before the Reserve Bank even talks about raising interest rates banks will have increased some of their medium to long-term mortgage rates. This could even happen in the next few weeks.

As yet, there is no reason for strongly believing that we face a future of sustained high inflation which will require an interest rate crunch. But borrowers should pay attention to the upside risks and the extreme uncertainty regarding how far and fast rates rise by favouring a spread of fixed rate terms rather than necessarily continuing to opt for the candy of the 2.29% one-year fixed rate – sweet as it may be.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets.

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