It was no surprise to anyone this week when the Reserve Bank announced that they would leave their official cash rate unchanged at the 5.5% level they took it to on May 24. Back then they expressed confidence that there will not need to be any further increase.
It is clear from their scant comments this time around that they retain that confidence.
They noted that the rate of growth in the world economy is weak, our export prices are falling, and supply chains are performing more efficiently. They noted falls in NZ household spending and house building, weakness in business investment, and freeing up of pressures in the labour market as a result of the surge in net immigration.
The labour market is highly relevant here because of the risk that high inflation gets locked into place by high growth in wages. In Australia this risk is quite high because the unions there are strong with national awards affecting many people in the private sector. In New Zealand this has not been the case for three decades and most recently we can see some indicators of labour market strength easing off.
There has been for instance a strong decline in the net proportion of businesses saying that they are finding it hard to get skilled people from a net 68% at the end of last year to now 38%. This is right on the ten-year average. The net proportion of businesses finding unskilled labour hard to source has fallen to 10% from 64% two quarters ago with an average reading of 21%.
These and other measures bespeak of slowing wages growth and this will partly explain the Reserve Bank’s confidence in inflation falling back below 3% before the end of next year. They have pencilled in the start of a series of interest rate cuts before the end of 2024.
This far out and with so many uncertain factors in play, we cannot rule out rate cuts starting in the likes of September 2024.
But there is a good chance that they start before then given some of the good downward movement recently seen in NZ labour market tightness measures and some gauges of inflation expectations.
For instance, the year ahead rate of inflation expected by consumers surveyed in a monthly survey run by ANZ and Roy Morgan has fallen to 4.3% from 4.8% just one month earlier.
For borrowers the situation is quite challenging.
There is an immediate cost saving to be made by fixing three years at a rate near 6.5% rather than fixing one year at 7%. Fixing five years is even cheaper at about 6%. But this is the wrong point in the interest rates cycle to fix long – unless one has a view that inflation is going to surprise on the upside and much more monetary policy tightening lies just down the track.
For most borrowers the optimal strategy is to take the cash flow pain of fixing short, hoping to ride rates downward and then fix longer from late next year or more probably in 2025. That is why fixing 18 months or even two years is considered optimal by many people.
Unfortunately, there are some people for whom taking the saving of fixing long-term is the only option they can pursue currently if they are to secure a mortgage and purchase a house before prices start cyclically rising in earnest. Bank test rates are at quite high levels now, often over 9%, and meeting debt servicing rules has become a bigger barrier for many new borrowers than having a 20% or near-20% deposit.
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