ANALYSIS: Monetary policy in New Zealand used to be relatively easy to understand. When the Reserve Bank wanted to slow down the rate of growth in the economy in order to get inflation down they would raise their official cash rate, banks would increase their mortgage rates, people would eventually pull back on their spending, businesses would lose some of their ability to pass cost increases into their selling prices, and inflation would come down.
But something quite interesting has happened here over the past seven weeks. On February 22 the Reserve Bank increased their official cash rate 0.5 percentage points and one would naturally expect that this would have led to an increase in bank mortgage rates. No increases occurred. Why was this?
The absence of any increases in fixed mortgage rates we could put down to the fact that the rate rise was expected and the cost to banks of borrowing money to lend at fixed rates to you and I reflects expectations for the cash rate and not where the cash rate is at the moment. Those expectations were met and therefore it's not surprising fixed interest rates have sat unchanged.
What was more surprising is that banks chose not to pass on the higher cash rate into their floating mortgage rates. That is probably because of the record low levels of residential real estate sales recently bringing very low growth in mortgage business and banks scrambling to minimise their undershooting of sales targets.
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But now, as of April 5, we have something potentially even more interesting. The Reserve Bank has again increased the official cash rate by 0.5 percentage points, to 5.25%. Banks may or may not increase their floating mortgage rates - we'll just have to see what the outcome is of competitive pressures. But what about fixed mortgage rates?
This is where things get very interesting. The markets were all ready for a 0.25 percentage point increase in the OCR. Therefore, in theory and based on what we saw in February, we should expect a rise in bank wholesale fixed mortgage rates. And one might then expect to see a round of increases in fixed mortgage rates. But is this likely?
Actually, no. The Reserve Bank has explicitly noted their concern at the way in which bank borrowing costs have fallen in recent weeks in response to developments offshore. It has clearly become concerned that in an environment where banks are not meeting their sales targets they might actually cut their mortgage rates and tolerate below average margins for awhile.
Independent economics commentator Tony Alexander: “Monetary policy in New Zealand used to be relatively easy to understand.” Photo / Fiona Goodall
Therefore, it looks like the Reserve Bank decided to increase the official cash rate 0.5 percentage points rather than the expected 0.25 percentage points, not to make mortgage rates go higher, but to prevent them from going lower. In fact, it is easy for me to write that because that is exactly what they said!
“However, wholesale interest rates have fallen significantly since the February Statement, and this could put downward pressure on lending rates. As a result, a 50 basis point increase in the OCR was seen as helping to maintain the current lending rates faced by businesses and households, while also supporting an increase in retail deposit rates.”
So, should people rolling off low fixed rates near 3.5% feel new worries about rolling onto a truly appalling rate in the near future? No, and that is partly because the April 5 rate rise and the comments explaining it from the Reserve Bank do not imply that the cash rate will rise higher than the 5.5% level indicated last November. In fact, whereas in February the Reserve Bank wrote “…monetary conditions need to tighten further…” this time no such comment was made.
Therefore, we could be at the cash rate peak right now. We shall see at the next review on May 24 whether one further 0.25 percentage point bump up is needed. Probably not.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
