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Harbour Navigator: Interest rate pain intensifies

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Hamish Pepper, Simon Pannett | Posted on Mar 27, 2024
  • Lenders have experienced only modest defaults on loan portfolios, underpinning an argument that monetary policy is yet to really bite.

  • However, we note arrears and KiwiSaver hardship withdrawals are rising before loan losses are felt, demonstrating consumer stress, and portending further spending reductions.

  • Unemployment is typically the final penny to drop, and indicators of the labour market suggest consumption will continue to be soft while arrears will rise in line with a higher unemployment rate.

Following the fastest RBNZ tightening cycle in New Zealand’s history, some people are still asking whether the impact of higher interest rates will be enough to return inflation to 2%. For others, this may seem slightly strange given the plethora of data showing the economy is struggling after the 525bp of hikes delivered between the end of 2021 and May last year. House prices are 13% lower than their peak, per capita retail spending has sharply dropped to early 2017 levels, and almost 30,000 additional people are unemployed. The latest set of GDP data for Q3 2023 showed an economy that is flirting with recession.

What more do these people need to see? Particularly when we know the peak impact of changes in the official cash rate is 6-8 quarters ahead and the last rate hike was less than a year ago. In its latest Monetary Policy Statement, the RBNZ seemed happy that tight policy is having the desired effect. For those questioning whether monetary policy has done enough, the focus seems to be around greater evidence of borrower stress. In their view, then and only then can we be sure that monetary policy is having the desired effect and inflation will safely return to 2%.  This view is predicated on mortgage arrears sitting around historic averages and very limited actual losses.

We don’t necessarily agree with the view that impairments need to rise sharply to bring about a fall in inflation. We think this distress view is overly anchored to the global financial crisis. Even then, the trend in recent data suggests we may be able to tick the broader box relating to borrower stress.

On a number of obligations basis, consumer arrears hit a seven-year high of 13% in January 2024, according to New Zealand credit bureau, Centrix. Arrears are defined as those who are behind by at least one payment. There are currently 480,000 people in New Zealand who have missed a payment. Of those, 174,000 have not made a payment for more than 30 days, which is almost 5% of those with financial obligations. Centrix says that financial stress is concentrated in those under 25 years old, where income and wealth is lower, but stress is increasing among 30- to 40-year-olds.

The uptick in missed payments has been most notable in utilities bills such as broadband.  The volume of credit card borrowing meaningfully fell during COVID and now sits at a similar level to a decade ago.  Here arrears remain below historic averages while Buy Now Pay Later arrears have risen sharply, perhaps suggesting some of the more financially stressed credit card borrowers have switched to Buy Now Pay Later providers.  The volume of auto lending has also fallen with a reduction in new vehicle registrations, where arrears trends are not concerning.  

Mortgage stress is becoming a greater part of consumer financial strain in New Zealand, but from a very low base. Most mortgage borrowers are now exposed to materially higher mortgage rates than those seen 2 – 3 years ago. For example, 1-year special mortgage rates have increased from a low of 2.2% in June 2021 to 7.2% today. The average outstanding mortgage rate has increased from below 3% in September 2021 to almost 6% today and is likely to increase further.  Centrix reports that 1.5% of home loans are in arrears, from less than 1% in 2022. RBNZ data from banks paints a similar story with non-performing housing loans increasing to $1.7bn or 0.5% of total loans in January, the highest proportion in 10 years. Non-performing loans are defined as those that are impaired or 90 days past due, with the total for New Zealand banks reaching almost $4bn in January or 0.7% of total loans, up from 0.4% a year ago.

This level of arrears does not indicate stress for the banks; it is too low to challenge loan loss provisioning and strong capital positions.  However, the trend and details suggest the consumer is indeed struggling.  Corroborating this, a sharp pick-up in KiwiSaver financial hardship withdrawals, according to data from IRD, also speaks to the difficulties currently facing some households. The number of monthly withdrawals on financial hardship grounds is now around 2,500, versus an average of around 1,500 per month in the four years prior to COVID.  

Businesses are also starting to feel the impact of a squeezed consumer. Business defaults have increased 28% over the past year and liquidations are up 16%, close to 5-year highs, according to Centrix. Unsurprisingly, retail trade was the sector hardest hit with a 60% increase in company liquidations over the past year. Construction, hospitality, and transport companies also experienced meaningful increases in stress and liquidations.

Looking ahead, rising unemployment and lower wage growth may pose new challenges for the economy, as inflation returns to target and interest rates begin to fall. Events to date have been stressful for households including the massive increase in the cost of living. Job losses and lower wage growth could see a ratcheting up of pressure and, in our opinion, further reduce consumption growth. Indeed, it is unemployment that transforms arrears into defaults.  Surveyed measures of the ease with which firms can find labour suggest the unemployment rate could rise rapidly this year to between 5% and 6%. These are corroborated by low levels of job advertisements and high rates of job applications per job advertised. An unemployment rate of 5 - 6% has historically led to wage growth, on an average hourly earnings basis, of 2 - 4%, roughly half the current rate. While we expect interest rates to decline over the next two years, just as it has taken time for higher rates to bite, it will take time for lower rates to provide relief and households will face headwinds for a while yet.

In bond portfolios we retain comfort holding bank bonds, however for some time we have avoided lower-rated tranches of asset-backed securities which are more exposed to rising arrears.

Returning to the outlook for interest rates, the RBNZ’s recent renewed focus on targeting 2% inflation doesn’t mean it won’t remain conscious of how much economic pain is incurred to achieve this. At the end of last year, the RBNZ’s Monetary Policy Committee (MPC) Remit was amended to remove the objective to support maximum sustainable employment, leaving 2% inflation as the sole target. The Remit, however, also states that in pursuing this objective the MPC shall seek to avoid unnecessary instability in output, employment, interest rates and the exchange rate.



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