Tony Alexander | Are Kiwis part of a slow moving car crash?

Taken from Tea with Tony March 2022


As New Zealand’s Omicron cases spiral, the Reserve Bank’s interest rate forecasts are on a similar trajectory. We’re hurting at the pump, the supermarket checkout, and everywhere in between. But the housing market is finally flipping the trend. Unemployment is at its lowest rate in history, and we’ve got a green light for our loved ones to come home with tourism even now a possibility.

Are Kiwis part of a slow moving car crash or are we driving the Volvo that with some decent personal driving skills might just bring us home safely albeit with a nasty petrol bill? Unless of course you were driving a government subsidised Tesla. Here’s Tony’s view.


OCR & Inflation – what’s going on?

The inflationary pressures in New Zealand and around the world are more than just transitory or temporary and Tony believes the Reserve Bank needs to start taking away the sugar, that is the record low interest rates, in order to slow down the pace of growth in the economy and start containing the inflation.  His view is that the economy was nowhere near as weak as the Reserve Bank was expecting. By the end of 2020, we were getting good growth. And yet the Reserve Bank kept interest rates at those record lows right through until October last year. And they should have actually started cutting back on printing money early in 2021. And at the same time, January, February, March of last year, then raising the interest rates as well.  Essentially, he believes they should have started doing what they’re doing now a year ago.


Interest Rates – how high can they go?

So how high can interest rates go?  While Tony cannot predict accurately, he believes the Reserve Bank now needs to raise rates quickly.  They will have to take them higher than would otherwise have been the case, if they had tightened more aggressively from 12 months ago.  Furthermore, he says the risk is that people are now going to over extrapolate the heights to which interest rates will go. The Reserve Bank have lifted the forecast for the peak in the official cash rate from 2.6% to 3.4%. So that implies floating mortgage rates will be about three-quarters of a percent higher than they were projecting three or four months ago.  He thinks over the next few months some people may predict floating mortgage rates will be above 7%.

Tony’s view is it’s unlikely rates will reach the same kind of rates we saw in 2008 when they reached 11%.  The Reserve Bank wants to see a slowing in growth in the economy and they’ve got two main weapons for doing that. One is increasing the interest rates and the other is to scare people.  The more scared people are about how high interest rates might go, the more consumers pull back on their spending and businesses are less likely to raise their prices as high.

So the Reserve Bank actually wants scary stories out there, which means the interest rates won’t go as high as even Tony thinks the Reserve Bank have projected.  He also still believes the cash rate peak will be 3% because he can see some of what the Reserve Bank is looking for is already happening.  This is especially true he says in the housing market where we’ve got house prices down for two months in a row, and they’re probably going to fall for the next couple of months as well.


OCR & Interest Rates – how does one affect the other?

The Reserve Bank changes the overnight cash rate (OCR), because it changes over time the cost to banks of borrowing money to lend out – the floating rate, one year fixed, two year fixed, all those interest rates. So the Reserve Bank can influence floating rates really strongly. And as you go out further along the yield curve to 1, 3, 5 years, the influence decreases, but it’s still there.

We’ve been in a similar situation in 2014/2015 when the official cash rate was 3.5%.  Back then Tony believes the one year fixed rate got just above 6% and the floating mortgage rates got to about 6.7, 6.9% or so.  Therefore he think it’s reasonable to anticipate that if we get the official cash rate going to about 3%, at a conservative guestimate the floating mortgage rates could rise to about 6.5% and the one year fixed rate to about 6%.


Fixed Interest Rates – what influences these?

Most people understand that if the OCR goes up it affects interest rates, but they don’t really know how. Essentially it’s wholesale versus retail interest rates and fixed rates are more impacted by wholesale borrowing from overseas so there’s two factors there.  If say overseas the United States long term interest rates go up all of a sudden, it’ll feed straight through to our three and five year fixed rates also reacting, not as much, but there’s an influence there. Whereas for the floating rates, the one year fixed rate is very strongly influenced by what the Reserve Bank is doing with monetary policy.

This is going to become quite important (as it was in 1998 and 2008) when our central bank will be tightening monetary policy, interest rates are going up. But what if at the same time you’ve got interest rates easing, the inflation outlook is improving in the United States?  You can get the short term interest rates going above the long term interest rates, that is, a negatively sloped yield curve. And that’s when it’s going to get interesting.

Tony believes at some point in the next 15 months he’s going to be telling us, “Well, now we’ve got one year fixed rates here. Oh, the five year fixed rate is lower. Do not touch the five year fixed rate with a barge pole.”  At that stage some people may think “But I’ve got to fix five years at 5.5%.  Because it’s cheaper than fixing one year at 6%, I’ve got to do it.”  Tony advises when this happens,  the thing to note is that if the yield curve is sloped like that, the Reserve Bank is basically screwing the bajeebers out of the economy. It means the inflation’s going to get beaten and those interest rates are going to fall away quickly.  And at that time Tony suggests you’ve got to take the pain of paying the current floating rate for a while, because if you lock in that rate, pretty soon you’ll be asking the bank if you can break that rate.  He states this is exactly what happened in 1998 and 2008. He suggests checking historical interest rates on the statistics page of the Reserve Bank’s website for more insights.

60% of Kiwi’s are coming off their fixed rates this year.  This could potentially mean a doubling of interest rates for some people.  If you’re in this situation, it can be helpful to sit down with a really good mortgage advisor who can help you figure it out and make a plan.


Tightening Monetary Policy – how quickly could it be under control?

Tony believes if the tightening monetary policy is effective, things could be back in control the second half of 2023.  The inflation rate is currently 5.9%. When we get the March quarter numbers out, he estimates it could be around 6.5%.  For this year, calendar 2022, inflation/change in your cost of living – they’re basically the same thing almost, it’s going to be high. But it’s next year where oil prices having recovered from pandemic lows, they’ll have fed through the system and we could even be getting some declines late this year through next year.  Tony suggests the supply chain problems are actually still getting worse at the moment because of considerations in China and of course related to Russia and Ukraine as well, but he expects they will be improving through 2023.

The key thing he says to note is the Reserve Bank, when they’re implementing monetary policy, they’re raising interest rates now and they know they pretty much cannot influence inflation this year because that’s done and dusted. It’s sort of locked into the system as it were. So their target of changing the interest rates now is inflation in 18 months. And so if they were to suddenly move aggressively in the next three months and increase interest rates another 1% or so, it’s going to have a big impact on inflation in the second half of 2023.

One of Tony’s key themes, for the moment is “don’t panic”.  He believes we will see scary stories about interest rates and the impact in the housing market, but to keep in mind this: the focus of the Reserve Bank is removing excessively loose monetary conditions, excessively low interest rates, excessively printing money.  He believes this is not the same thing as they’re now going to put in excessively high interest rates, excessively pulling back on printing money, etc.  It’s a different thing. The Reserve Bank’s actions are mainly about removing unsustainable stimulus, not deliberately creating a recession to get inflation under control. They are different things. So again, don’t panic as this year goes by.

Tony says if you got a mortgage at any time over the past decade, the bank worked out your ability to service at least 6.5% interest rate and up until a couple of years ago, it was still 7.5 – 8 %.  He’s mentioned earlier the interest rates may get to a 6 – 6.5% range.  So there’ll be very few people who will not be able to continue to meet their interest payments.  Especially in the context of a strong labour market with an unemployment rate at 3.2%, businesses are screaming out for staff that they cannot get.  The banks will keep this in mind “we know you can service a 6.5% interest rate and you’re not going to be made redundant. Even if you are, there’s another job for you down the road.”  So Tony’s view is we’re not going to see a wave of mortgagee sales coming along this time around. And in fact, even though he’s warned of scary talk about a recession he’s not sure many of the journalists are going to say, “we’re going to see a wave of mortgagee sales”.


Population Changes – what does the data say?

COVID seems to have changed things for the regions. Are we seeing this impossible reversal of urbanisation?  Is Tony seeing more people moving to the regions?  Tony says the finding the data to support this is a little bit difficult. We need the subnational population numbers from Stats New Zealand to be updated. We still only have the numbers up till June last year and they do show some extra growth happening out in the regions but they’re nothing too much. He also suggests there just isn’t the capacity for a lot of people to leave the cities and move to the regions because the properties simply have not been available.

He says in contrast, we can see overseas working from home has been a huge phenomena underpinning for instance, in Australia, a doubling of the number of people shifting from the cities to the regions beyond what would normally be the case.  In New Zealand, he thinks partly because of the distances involved, there hasn’t been quite so much of a shifting by the people working from home out to the regions.

But he does believe there has been a shifting by some older people cashing up their investment assets or their house price in Auckland getting a lot better price than they were anticipating and choosing to move to the retirement location perhaps two to three years earlier than they were planning.  This means that if somebody was to present to Tony right now, data showing really strong population growth in these regions over the past couple of years, his response would be, “I wouldn’t over extrapolate that because some of the people that moved to the regions nine months ago, they were going to do it in two years. Now they are already there and there’s going to be a bit of a slow down on some of that migration.”

So, he doesn’t think this is an abrogation of urbanisation.  He continues to expect that Auckland’s population growth rate will exceed the rest of the country tremendously over the next couple of decades. They will continue to need investment in infrastructure there, but there is probably still a little bit of a catch-up construction of houses to be done in some regions. So they’re still a little bit behind the plate just here and there.

What about the impact of Kiwi’s returning home? Are they going to re-stimulate our housing market and make everything okay?  In short Tony’s view is no.  His view is if you’re one of the 1 million Kiwis overseas one reason is to escape your family and the other is to earn more money. So why would they come back to New Zealand for high house prices, high costs of living and maybe half the wages they’re getting in London or in Australia?  His view is that while some Kiwis will come back – we will thankfully see some wonderful images of hugging at the airports etc. behind the scenes a lot of people will already be planning where they’re going to be moving to in Australia. And the plan will be, “I’m going to go to Australia for three to five years, I’m going to make a nest egg, and then I’ll come back to New Zealand.” But the fact there’s about 650,000 Kiwis in Australia suggests that most after moving across there, stay in Australia. So he doesn’t think there is a big wave of Kiwis coming back to New Zealand to give a new stimulus to the housing market.


CCCFA – what’s Tony’s view?

Tony has mentioned before that the CCCFA or Consumer Credit Contracts and Finance Act, is responsible for a credit crunch in our industry. While NZHL is a little better geared up than most to deal with it, it is still not without its challenges. The Commerce Minister has indicated some tweaking, what’s Tony’s take? Does he think it will ease things a little bit?

Tony believes there will be some tweaking, but the Commerce Minister has said that “he felt banks were doing some irresponsible lending before December 1 when these two changes came into play.”  Tony doesn’t agree with him necessarily on that and mentions he also said, “oh, it’s actually not the CCCFA changes. It’s the LVS. The fact banks cannot do as much low deposit lending.”  Tony believes that is definitely a factor in there, but no, it’s the CCCFA. If they only tweak it a little bit, you’re still going to have a lot of people going to have to save up an even bigger deposit than was the case previously. They’re going to have to generate extra spare income every month there.  And so he thinks that while it will ease up soon in the next few months, it is still going to constrain the overall rate of credit growth in New Zealand and act as another slowing factor for the house market overall. But he thinks we’ll just have to wait and see, as far as the legislation goes because with this government predictability of legislative changes has turned out to be relatively difficult to do.

So, are we in a predestined, slow moving car crash, or driving that Volvo with some skills to manage our own destiny? What does Tony think? His view is the rule has always been, if you know you’re going to crash one day, you buy a Volvo. But, basically the New Zealand economy is well underpinned by very strong demand for our primary products overseas.  Fonterra is going to be making a record dairy pay out this season. Next season is looking just about as strong. We’re looking at people opening up, eating in restaurants, demanding our red meat and beverages overseas. We’re looking at a free trade agreement being signed with the United Kingdom maybe a bit further down the track. There’s one there with the European union as well. We’re looking at tourists coming back into the country.  We’re looking at a lot of stuff having to be built in New Zealand, infrastructure, some commercial buildings to go up. House building’s still strong this year, but he expects house building will actually be falling away over 2023. And the strong labour market will be a big insulating factor against the extent to which we pull back on some of our spending.  So he says we’ve grown 5% in the year to September last year for our economy. Maybe we’re looking at about two and a half percent, he thinks is reasonable assumption for the next year and the year after that. It’s okay. It’s not stellar, but it’s okay.


Find out how a changing market impacts you

As always, if you have questions about how a changing market impacts you and your home loan structure, we’re here to help. Book an appointment with your local consultant today.

Click here to view the full Tea with Tony episode.   


*Please note – Tony Alexander is an independent economist. His views are his own and not necessarily shared by NZHL or vice versa. Tony’s Thoughts is brought to you by NZHL in a sponsored capacity.