ASB increased all its fixed mortgage rates yesterday, including the highly popular one year rate by 0.36% to 2.55%. We expect other major banks to follow, likely marking the end of a multi-year decline in New Zealand mortgage rates.
Many households will soon be exposed to these rates as almost 80% of outstanding mortgages are either floating (12%) or fixed for less than one year (65%).
Further increases in mortgage rates are likely as the economic expansion supports a removal of monetary policy stimulus and higher bank funding costs.
We think households in aggregate can manage higher rates. Debt servicing costs are historically low and there is some evidence that mortgage holders are currently paying off a greater proportion of principal, implying a buffer to rising rates.
Despite substantial increases in wholesale interest rates over the past 6 months, retail rates have mostly declined as the Reserve Bank of New Zealand has kept the Official Cash Rate unchanged and offered cheap bank funding through its Funding for Lending Programme.
The Reserve Bank of New Zealand is now more confident in the economic outlook and forecasts a larger amount of interest rate hikes than markets currently expect, beginning in Q3 next year.
As financial markets price the prospect of earlier and more rate hikes, increasing banks’ wholesale funding costs, retail interest rates are likely to rise, starting with 2-year and longer mortgage rates over coming months, while meaningful increases in term deposit rates may happen later and be more gradual.
Higher inflation and the prospect of a reduction in central bank support is becoming a concern among financial market participants.
We think this risk is low given most economies have spare capacity that is keeping unemployment rates higher and inflation lower than central banks desire.
The ongoing threat of higher inflation and reduced monetary stimulus, however, is likely to lead to choppy trading conditions as investors manage the transition away from the low inflation and falling interest rate environment seen in recent years.
We hope that the following Q&A gives you an insight into our thought process.
Economic strength to challenge the RBNZ’s dovish stance
Market expectations of additional Reserve Bank of New Zealand (RBNZ) stimulus, for instance moving to a negative Official Cash Rate (OCR), have been tied to continued cautious communication from the central bank. Interest rate markets today price an OCR of -0.25% in one year’s time.
The economy, however, is in much better shape than the RBNZ expected, which presents a challenge to its uber-dovish stance and the prospect of a negative OCR next year.
In our view, the likely launch of a Funding for Lending Programme (FLP) as part of its 11 November Monetary Policy Statement (MPS) further reduces the need for additional stimulus.
We see the distribution of future interest rate outcomes skewed higher.
As market interest rates in New Zealand decline further, additional consequences are revealing themselves. The theme of accelerating progression of longer-term trends continues.
Wholesale interest rates continue to decline, with the Government’s PREFU announcement being the catalyst this week, due to a $10bln reduction in the size of the Government Stock issuance program for the 2020/21 fiscal year. The five-year New Zealand Government bond now trades at a negative yield, joining the one and two year maturities. 35% of outstanding nominal New Zealand Government Stock is now in the “negative rate” club.
This week the Auckland Council issued the longest maturity bond in New Zealand for more than fifty years. The ability of a council to issue 30-year bonds in the domestic market is a notable milestone in the ongoing development of the New Zealand capital market.
We think the RBNZ reaction function has become more dovish with lower and flatter yield curves the primary goal in the face of persistent health-related downside economic risks.
The Bank expanded its QE programme by more-than-expected last week from $60bn to $100bn and said it is prepared to implement a negative OCR alongside direct lending to retail banks at interest rates close to the OCR, if required.
Interest rates have fallen in response, but NZ government bonds now look expensive versus their global peers and a sharp rise in breakeven inflation rates suggest that economic risks may lie in both directions.
Some of New Zealand’s non-bank mortgage lenders have provided detailed data that illustrates they appear well-positioned to weather an increase in non-performing loans when COVID-related loan deferrals expire
Our various probes into the big banks indicate no cause for alarm, albeit we expect loss provisioning needs to rise and small to medium-sized enterprise (SME) lending trends need to be monitored