Tony Alexander | The turning of Inflation and Interest Rates | NZHL

Taken from Tea with Tony | January 2023

As we’ve started to see a dip in the 5-year fixed rates, Tony questions whether the inflation and interest rate outlook is turning.

And will this flow through to shorter terms and what can we expect to happen from here? 

Read on for Tony’s view.

New Zealand’s Economy 

In November last year, the OCR (Official Cash Rate) rose by a record .75% and the Reserve Bank increased its peak prediction to 5.5% (rather than 4.1%) while speaking of an increased likelihood of recession alongside a rise in unemployment to 5.8% (from 3.3%).

According to Tony, these comments have sparked additional concern for borrowers and had an economic impact – particularly in overall sentiment as many homeowners embrace worst-case scenarios when considering interest rate rises and their household finances.

Tony notes significant economic negatives and expects a delayed impact on economic activity. With decreased house prices (-15%) and businesses showing less intention to hire, driving intention to cut back on spending according to his surveys.

A combination of interest rate rises, higher housing stock levels, and material and labour shortages, will see a fall in house construction over the next couple of years, with the current high number of developments being unsustainable when demand has pulled back, Tony explains.

Stimulatory Factors 

According to Tony, there is still a chance of avoiding a recession due to strong stimulatory factors including – the recovery of inbound tourism numbers, the return of foreign students boosting the main city centres, and net migration moving into positive territory – 6 – 12 months earlier than Tony previously predicted. The latter of which may push up business sentiment and offer support to those struggling with labour shortages.

Additionally, although the Covid lockdown spending boom has well passed, Tony notes some sectors (aged care, health care, and many horticultural sectors) are still undergoing long-term growth.

Recession Certainty

While there are a lot of factors at play and a recession isn’t guaranteed, if we do have a recession in New Zealand, it will be relatively shallow, in Tony’s opinion. Tony explains; while business revenue can easily go backward (within a month or year), before going back up again, a recession is where a higher-than-usual number of businesses experience a revenue decrease causing widespread spending caution and a fall in sentiment.

In New Zealand, recessions can be influenced by significant exchange rate rises to impact the demand of the export sector. However, the Kiwi dollar is currently not putting pressure on the economy by being vastly overvalued.

Tony notes commodity prices falling away can also contribute to a recession. However, while there has been a small easing recently – particularly in the dairy sector – overall, prices remain fairly stable. Furthermore, there is no fresh financial crisis where large share market prices are falling away – as seen in previous recessions like the Global Financial Crisis.

Interest Rates and Inflation and the Easing Economy

At the time of writing, one lender (with more to follow), increased their 1 and 2-year fixed rates while cutting their longer-term rates (3-5 years). The decrease, Tony explains, is due to a lower cost of borrowing for lenders with a growing expectation that global inflation is under control.

While in New Zealand low levels of consumer, business, and investor confidence indicate an economic weakening which will result in a loss of pricing power for businesses and bring inflation down. Tony notes the December 2022 quarter inflation number at 7.2% was unchanged (from the year to September), and while still high, this number wasn’t a shock as in the previous quarter.

Erasing the risk of further inflation shocks will result in a shift in market attention with a loss in wage bargaining power for employees and the price-setting ability of businesses as stocks start to build up and consumer spending pulls back.

But what does this mean?

Tony says this is an indication of a turning in the outlook of inflation and interest rates -which is already evident in the reduction of longer-term interest rates.

However, Tony cautions, this can take a lot longer to filter through to the shorter-term rates, and while we may see movement in the 2-year fixed rates over the coming months – the 1-year and floating rates will take a lot longer. Additionally, Tony notes floating rates are influenced by the OCR and will likely go up further.

Tony further cautions, economists don’t have an accurate time frame for the interest rate decline – while the slightly cheaper 5-year rates might be tempting for borrowers, Tony warns we are near the top of the cycle, so fixing in a longer rate now could see you paying a higher rate for longer.

The Housing Market 

Tony notes negatives outweigh the positives and will continue to do so over the next few months. While there will be a ‘bottoming out’ at some point, it will be difficult to pinpoint when, particularly in the uncertainty of election year.

Tony says current interest rate levels and expectations for where they will go are a big driver for the housing market- the current interest rates alongside forecasts of further OCR increases have seen buyers stand back.

However, Tony expects long-term or multi-generational investors – who have seen a few housing market cycles – will begin to step back into the market as they recognise the bottom of the cycle, and the opportunity to pick up well-priced properties.

According to Tony, currently, there is still an absence of any evidence of investor selling. However, Tony’s surveys show an uptake in investors’ interest in purchasing as their fears of further pricing decreases begin to fall away.

Tony emphasises we’re not yet at the point of a housing market cycle turn – which will not start until there is certainty in the decline of interest rates.

Key Take Aways

At this stage, Tony is still 50/50 on whether a recession will hit New Zealand.

And, while interest rates are changing, economists are not yet confident about the timing of interest rate declines – which is largely dependent on evidence of inflation falling away.

Lastly, Tony advises home loan borrowers to get advice (such as from your NZHL Mortgage Mentor) as home loans should be personalised to best suit individual circumstances.

To watch Tea with Tony, click here.

Find Out How a Changing Market Impacts You

If you have questions about how a changing market impacts you and your home loan structure, we’re here to help.  Book a free chat  with your local consultant today.

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