ANALYSIS: I produce a publication each week which goes to almost 29,000 people and up until early August I would produce a table showing where I expected bank one-year fixed mortgage rates would be over different periods of time. I stopped producing that table from the middle of August and all I can say is thank goodness I did because the situation for interest rates has changed to quite a degree over the past couple of months.
I stopped it for a number of reasons. An obvious reason was that the international economic and interest rate environment was proving very difficult to predict. We were seeing central banks offshore raising their interest rates at a faster pace than previously expected as measures for labour market strengthen and inflation kept turning out to be stronger than had been expected.
It was getting fairly obvious that inflation offshore was going to be harder to get under control than earlier thought and this would imply higher interest rates, which in turn would also imply higher interest rates in New Zealand.
A way in which interest rates get pushed up here is the Kiwi dollar falling and what I've learned over the past three and a half decades is that predicting currencies is a fool’s game. Certainly I wouldn't have predicted that we would be sitting currently near 56 US cents as compared with 64 cents back then.
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The lower Kiwi dollar means more inflation here because the prices of imported goods naturally will be higher than earlier anticipated.
I also stopped producing the set of interest rate forecasts because it was becoming obvious that the traditional links between changes in bank wholesale funding costs and the fixed interest rates which banks set were falling apart.
On average over the past two years the margins banks have run between the interest rates they charge you and I and what they pay in the wholesale markets has been about 2% for each of the terms from one year out to five years.
But banks were failing to respond to their funding costs going up so all of the assumptions I've been making about the link between bank borrowing costs and fixed interest rates had to get tossed out the window.
Well, as I say, thank goodness I did throw the table out because what we have learned this week is that the inflation rate in New Zealand did not fall to 6.5% as expected but instead was virtually unchanged from the previous 7.3%. Inflation here, as overseas, is proving more intractable than anticipated and that means interest rates here will go higher than previously expected.
Tony Alexander: “Borrowers are going to have to allow for their costs being slightly higher for the coming 12 months.” Photo / Fiona Goodall
This doesn't however necessarily mean they won't still be falling from the end of 2023 as has been my view for some time now. In fact, the more that interest rates go up now, the greater the chance that they will be cut further out because the greater is going to be the negative impact on our economy.
I still don't believe we're going to have a recession given the strong support from good international export prices, the low New Zealand dollar, high job security, the return of international tourists, the return also of foreign students, and good fiscal numbers for the New Zealand Government which must surely produce an easing of fiscal policy in the 2023 election year.
But borrowers are going to have to allow for their costs being slightly higher for the coming 12 months than we were all thinking before the inflation number came out. Do I think the interest rate rises will be enough to cause new weakness in the housing market?
Only to a minor degree. First-home buyers, I believe, will still be looking to take advantage of the good stock of listings, the fallen prices, and the easing in bank lending conditions in recent months. The main impact is likely to be any investors who were thinking about following the first-home buyers back into the market will probably step back into the shadows again.
What they will be waiting to see is where the political opinion polls go through 2023 and if it looks like we will get a change in government which will restore the deductibility of interest rates and the incentive to provide rental accommodation in New Zealand.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
