ANALYSIS: About three weeks ago banks increased their fixed mortgage rates by about 0.5% for the terms from one year out to five years. Many people think these rates are unusually high and will cause quite a drag on the New Zealand economy. But the new level of interest rates is not far removed from the average for the period in the 10 years ending in 2018.
When considering whether interest rates are unusually high or not it's best to completely ignore the period from 2019 through into 2021. In 2019, people were worried about deflation and the talk was all about negative bank deposit rates. Over 2020 and 2021, the discussion of course was all about the pandemic and the economic devastation expected to result from that.
That devastation did not arrive and with the unusually loose monetary conditions over 2021 in particular, we now have a lagged burst of inflation in New Zealand and around the rest of the world, which central banks are belatedly trying to fight.
They will be successful. It's only a matter of how high interest rates need to go in order to get the disinflationary pressure they are seeking. My belief is that tight monetary policy is gaining traction in the New Zealand economy. For instance, my monthly Spending Plans survey has been run for two-and-a-half years years and the most recent result shows a net 28% of people plan to cut back on their spending over the next three to six months.
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This is the lowest reading on record and tells us that the weakness in retail spending already recorded this year is going to continue through summer into 2023. That is not good news for retailers, but it is excellent news for those who have borrowed a lot of money over the past few years and are worried about where interest rates are going to go.
The Reserve Bank is going to keep tightening monetary policy, but the bulk of this tightening has already been factored into the wholesale interest rates, which banks must pay when they borrow money to lend to you and I at fixed interest rates. Therefore, further upside in interest rates may not be all that much if any from current levels.
Independent economist Tony Alexander: “It is virtually guaranteed that the Reserve Bank will increase the official cash rate from 3.5% to at least 4%, even 4.25%.” Photo / Fiona Goodall
Do we have any evidence in hand beyond the fall in spending intentions showing the impact of these interest rate rises of three weeks ago? Yes, we do. From my monthly survey of real estate agents, we can see that first home buyers are still in the market, but investors have run for the hills again.
But what about owner-occupiers? These are the people who will be selling and buying in the same market so what prices are doing doesn't really matter all that much. I can see from my spending plans survey that there has been a decline in the net proportion of people planning to buy a house in which they will live themselves.
This is important. It tells us that like investors, owner-occupiers are not following first time buyers back into the residential real estate market. For first time buyers this is excellent news. They face a situation where prices on average around the country are down by almost 13% from a year earlier, the number of properties listed for sale is up by 72% from a year ago, and vendors are increasingly willing to negotiate, recognising that they have no hope of achieving the prices they could have got a year ago.
The next review of monetary policy happens on November 23. It is virtually guaranteed that the Reserve Bank will increase the official cash rate from 3.5% to at least 4%, even 4.25%. But there is a good chance that the Reserve Bank does not express great concern about what is happening with inflation. International shipping costs are coming down, commodity prices have eased recently, my survey shows that consumer spending is being crunched, house prices continue to fall, and then there is one more thing.
Central bankers offshore in recent weeks have been noting that high inflation rates at the moment are the result of the lagged effect of extraordinarily loose monetary conditions over 2020 and 2021. Monetary policy works with a lag. What that means is that with monetary policies tightening from over a year ago in New Zealand and more recently in other countries there will be extra downward pressure on economic growth rates and inflation over the coming year even if central banks do not change their interest rates any further from current levels.
The outlook remains very uncertain. But I am sticking with my view that the housing market on average around New Zealand is set to bottom out around about autumn and then record mild growth over the second half of 2023 supported by medium to long term fixed interest rates falling away.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
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