Homeowners and buyers are feeling the pain from rising mortgage interest rates, but many have no idea why they’re being put through the wringer, or what this OCR thing is anyway.
Many blame the Government for interest rate rises, but the most direct cause of interest rate rises is the Reserve Bank of New Zealand (RBNZ), which is independent.
It’s the RBNZ’s job to raise and lower the Official Cash Rate (OCR), which the RBNZ defines as "overnight interest rate set by the Reserve Bank. We transact with other banks near this rate, and so it influences the rates that other banks offer to their customers." So each time the OCR goes up or down, the banks follow suit roughly with their mortgage rates.
Why is the Reserve Bank pushing up interest rates?
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The last thing the RBNZ wants to do is cause pain to ordinary New Zealanders. Its job, however, is to keep inflation within a 1-3% range and support maximum sustainable employment. The idea is that low and stable inflation is best in the long run for New Zealanders. But there are always trade-offs.
When it pulls the interest rate trigger to raise the OCR, it does so to reduce the cash in New Zealanders’ pockets, which has the effect of slowing spending and bringing inflation down.
The good news is that the ratcheting up of the OCR we’ve seen since October 2021 is going to work, says independent economist Tony Alexander.
“It always does. That’s the thing about raising interest rates to fight inflation - there's no limit on how high you can take the interest rate when you're fighting inflation. It's always just a matter of how high do interest rates need to go? How long do they need to stay up there for? So definitely, the interest rate rises will work.”
It's just that no one knows how high rates will need to go or for how long to get this cycle’s inflation down, he says.
Roots in the pandemic
The roots of the pain felt by mortgage-holders dates back to the beginning of the pandemic. When Covid hit, few, if any, experts could predict its effect on the economy, and the Government and RBNZ pumped money into the economy with wage subsidies and quantitative easing (printing money), says Mark Lister, investment director at Craigs Investment Partners. That cheap money, combined with supply issues throughout the pandemic, and food price increases thanks to the Ukraine war, pushed prices for goods and services up. Wage rises have also added fuel to the fire.
Independent economist Tony Alexander: "The interest rate rises will work.” Photo / Fiona Goodall
Lister says that central banks around the world took similar actions bringing interest rates down in the early stages of the pandemic, then raising them to counter inflation in 2021 and 2022.
More ouch
The trouble is that OCR rises to date haven’t been sufficient to crack the inflation nut. The RBNZ warned New Zealanders in late November to brace for a recession. A recession will be collateral damage for getting inflation under control.
It predicted that the OCR, which is currently 4.25%, is likely to peak at 5.5% in 2023.
To put that in context, as recently as August the RBNZ was predicting the OCR would peak at 4.1%. But then inflation figures came in at 7.2%, well above the 6.5% most experts expected. In November annual food price increases came out at 10.1%, another shock.
The war on inflation is a world war, not just something faced by New Zealanders, says Jarrod Kerr, chief economist at Kiwibank. Central banks around the world are facing the same nightmare scenarios.
Nonetheless, the New Zealand inflation numbers meant the RBNZ came out all guns blazing on the OCR front, with a jumbo rise of 0.75 percentage points in November and a warning of more to come. The more to come means we’re not there yet in terms of how high the OCR will go.
The November rise saw mortgage rates rise again and floating rates are expected to break through the 8% barrier. While 8% mortgage interest rates might feel shocking for people who got on the property ladder at 2%, historically 7-8% is more like returning to the norm.
House prices fell sharply in 2022 and those who bought at market peak are in danger of falling into negative equity. Photo / Ted Baghurst
Alexander doesn’t think we’re heading back to 1970s/1980s-style inflation. “Definitely not. Because back then central banks did not act quickly to suppress inflation. Now, it's exactly the opposite. They do act quickly. That’s one answer. Secondly, back then there tended to be cosy relationships between businesses and unions. So unions would get wage increases [and] businesses would put prices up. The institutional relationships lead to wage price spirals, and I don't see that happening this time around.”
It could be worse
Homeowners are feeling the pain. It could have been worse. In the 1990s the RBNZ was given the task of keeping inflation under control after a disastrous era for homeowners in the 1980s when mortgage interest rates rose above 20%.
Blunt tool
The OCR is often seen as a blunt tool. Sometimes OCR rises mean it moves one objective such as inflation closer to the target of 1 to 3% to the detriment of employment. Or vice versa. The irony is that New Zealanders still feel wealthy and are still spending, despite the mortgage rate rises, says Nick Goodall, head of research at CoreLogic. The sheer size of the increases in the value of their properties means that people are still feeling the wealth effect, even if their mortgage repayments are rising.
Yet until New Zealanders stop spending, the RBNZ is likely to keep pulling the trigger on OCR rises.
There is a point, says Goodall, where the RBNZ can’t push the OCR up more. “[The RBNZ] is fighting the number one evil, which is inflation. Come next year we are going to have to consider not just inflation, but our economy with regard to recession and the potential risks of unemployment.”
Kiwibank chief economist Jarrod Kerr says the war on inflation is a world war. Photo / Fiona Goodall
Goodall says the RBNZ will also need to consider the impact of falling house prices, which is pushing homeowners into negative equity. “A house is our largest asset. It is going to start to affect people if their property value starts to get 20 below where it was.”
Outlook for 2023
More pain is on the way for 2023. Here are what some of the bank economists are predicting:
ANZ: The tone of the RBNZ’s Monetary Policy Statement in November when it last put the OCR up was more hawkish than the ANZ’s economists expected. “We have revised up our forecast OCR track, adding to our existing 75bp hike in February a 50bp [0.5%] hike in April and a 25bp hike in May, which would take the OCR to a peak of 5.75%,” says Sharon Zollner, ANZ’s chief economist.
BNZ: The predicted recession for 2023 is going to be a mild one by historical standards, but a recession nonetheless, says the BNZ’s economists. They’re predicting that after peaking at 5.5%, the OCR will start to fall in February 2024, assuming the previous OCR rises have done their work.
Westpac: Westpac’s economists are predicting a 0.75 percentage point OCR rise in February as many others are, and a further 0.5 percentage point rise in April. Acting chief economist Michael Gordon also expects interest rates to start falling with OCR cuts from early 2024. Gordon says the lesson of the Global Financial Crisis (GFC) is that a recession can break the back of inflation fairly quickly. “Admittedly the scale of the inflation problem is greater now than it was in 2008, or indeed at any point in the last 30-odd years of inflation targeting. But we shouldn’t lose sight of the fact that monetary policy works, eventually.”
Kiwibank: “Hike till it hurts and then hike some more, and continue to hike even with a recession coming,” Kerr said immediately after the last rate hike. The idea is a stitch in time in 2023 is going to save nine. “Inflation rates are simply too high. And the credibility of the proud inflation-fighting central bank is being questioned. Our focus now turns to the February meeting [when the OCR might be lifted again]. That might mean another 75bp hike in the cash rate.” Given that other central banks are slowing rate hikes, New Zealand’s RBNZ might moderate its language by February, says Kerr. “We suspect the RBNZ, along with every other inflation fighting bank, will be in a position with weakening growth and improved inflation expectations. We hope.”
