OCR Commentary – June 2014

On Thursday 12 June, the Reserve Bank of New Zealand (RBNZ) lifted the Official Cash Rate (OCR) by 25 basis points to 3.25% as anticipated. What will be the impact of this increase?

What will be the impact? Floating Mortgage Rate –

  • Floating mortgage rates will increase, with lenders likely to follow ANZ’s lead and lift floating rates by 20 to 25 basis points over the next week or so
  • Why? Floating interest rates are benchmarked to and moves in conjunction with a prime interest rate such as the OCR. If OCR goes up, so too will floating mortgage rates

What will be the impact? Fixed Mortgage Rate –

  • Fixed mortgage rates should stay relatively “fixed”, so to speak
  • Why? Fixed mortgage rates are heavily dependent on swap rates in the wholesale markets, which in recent years have been very low for longer maturities due to a global trend towards lower interest rates
  • In addition, low cost of funds available from overseas allow lenders with access to offshore funding to reduce their mortgage rates without affecting profit margins. In the case of New Zealand, local banks have been able to take advantage of this and in recent months, compete fiercely to take on customers for fixed mortgages

What will be the impact? Exchange Rates –

  • NZD likely to increase in the immediate term
  • Why? A higher OCR makes NZ an even more attractive investment destination for offshore money given low interest rates and yields available in USA, UK and developed European economies such as France and Spain.
  • More demand to invest in NZ means more demand for the NZ currency

What will be the impact? House Price –

  • Unlikely to have a large impact in the short term
  • Why? A large number of mortgage holders have switched over to fixed rate mortgages already, so their financing costs are likely to hold steady in the short term. This means the recent OCR increase will be unlikely to adversely affect demand through an increase in interest burden
  • History suggests rising interest rates don’t immediately deter demand

On the whole, two- and three-year fixed mortgage rates have on average, increased by 15 basis points since the beginning of the year, whereas floating mortgage rates have increased by 75 basis points due to OCR rises. Looking forward, the most recent OCR increase will serve to further flatten the yield curve, making floating rate less attractive compared to fixing in the short term, an area which the banks are competing fiercely for customers.

 

What is the OCR likely to do going forward? Consider the following:

Economy –

  • Recently released figures from Statistics New Zealand show GDP increased 3.3% for the year ended March, with a 1% increase for the March quarter. This increase is driven by strong growth in construction activity, which grew 12.5% for the March quarter. Given the RBNZ is operating its policies under the assumption of a forecasted growth rate of 2.75%, the higher than expected rate may indicate inflationary pressure in the short term
  • Export prices are expected to drop by around 10% due to weakening dairy and primary export prices, which will likely take some lustre off strong terms of trade which is underpinning GDP growth alongside construction. In the medium term, exports are still looking to be in a strong position to support GDP growth despite weakening prices due to historically strong terms of trade

Migration –

  • Net migration has increased significantly to historically high levels over the past year, caused by lower departure numbers and a surge in temporary permits to bring workers into Christchurch. More Kiwis are now opting to stay in, or come back to, New Zealand, which reflects New Zealand’s warming job market as well as signs of jobs prospects cooling in Australia
  • Strong net migration caused by lower departure numbers means the impact on housing demand in this boom is likely to be different compared to previous migration booms, typically caused by high inflow of new migrants. However, the RBNZ still has concerns towards the possibility of stronger than expected inflow, which may lead to a large upswing in demand and higher inflationary pressure that calls for higher interest rates

Policy management –

  • The RBNZ has deemed the LVR restriction to be a successful tool in controlling house price inflation, estimating its implementation to account for a reduction in annual house price inflation by about 2.5% to 3.5% for the year ended March 2014 compared with what the rate might have been in the absence of the LVR restriction
  • As of June 2014, it is looking unlikely that the RBNZ will lift the LVR restriction this year. However if house price inflation remains under control through the remainder of the year and into the first half of 2015, it is likely that we may see the restrictions begin to gradually ease in 2015

Taking these factors into consideration, it is looking more likely than not that the RBNZ will be increasing the OCR on July 24th. However given the frequency of recent increases, it is quite possible that we will not be seeing another increase after July until at least year end 2014.

 

Disclaimer

The information provided in this article is not intended to provide a comprehensive statement of relevant laws and should not be used as a substitute for legal advice. Please consult an expert for advice tailored specifically to your own circumstances.

Published on Friday, June 20th, 2014, under Finance, Law, Insurance

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