New Zealand has done something which will have a profound impact on its economy. Now Aussie mortgage payers wait for their moment of truth.
When we think about interest rates within our collective consciousness, they are generally perceived as something that is extremely slow to shift direction. Like a giant supertanker that takes miles to change direction, once a course in the direction of rates has been set there is a great deal of inertia propelling them in that same direction for years to come.
This has been very true of Australia’s own Reserve Bank.
After raising rates for the last time in November 2010, the course of interest rates has been on a downward trajectory for almost a decade, without fail.
However, with the RBA’s cash rate sitting near 0 per cent, eventually there comes a time when a course in the opposite direction must finally be considered.
So far Reserve Bank Governor Philip Lowe is charting a supertanker-like course, which will see rates begin to rise around three years from now in mid-2024.
Despite building inflationary pressures in the United States and elsewhere that are pressuring central banks to change course, so far Lowe appears steadfast in his resolve to keep rates where they are.
Interest rates in New Zealand
Just across the Tasman, the Reserve Bank of New Zealand (RBNZ) appears to be charting a very different course. An approach which resembles the agility of a fast-moving powerboat, rather than the supertanker style course, taken by the RBA.
But this wasn’t always so.
At the beginning of the year a survey of Bloomberg economists expected that the RBNZ would cut rates even further and by the end of 2021 they would sit at 0 per cent.
In late May, the RBNZ projected that interest rates would remain on hold until at least September 2022. RBNZ Governor Adrian Orr emphasised that the projections were “highly conditional” on the Kiwi economy recovering as well as expected.
In a press conference that followed, Mr Orr further tempered the RBNZ’s projections with caution.
“We are talking about the second half of next year. Who knows where we will be by then,” he said.
In mid-June, ANZ brought forward its projection of the first RBNZ rate rise to February 2022, on the back of strong GDP growth.
Now just a few weeks’ later things have changed course almost entirely.
Investors and financial markets are now pricing in a 90 per cent chance of interest rates being hiked by the RBNZ at their very next meeting in August.
Despite the RBNZ forecasting that it would be 16 months before rates would rise, higher inflation and market expectations of a rate hike could see them moving up in a matter of weeks.
But the rate hikes are not expected to stop there.
According to forecasts from Westpac economists, rates are predicted to go up in August, October and November. This would raise the RBNZ cash rate by 0.75 per cent, from its current record low of 0.25 per cent to 1 per cent.
In a little over six weeks from the RBNZ cautiously confirming no rate hikes until September 2022, the RBNZ’s approach to interest rates has been completely transformed.
If that happens, New Zealand will become the test case for rising interest rates throughout the Western world.
What this all means for house prices
While the strong economic recovery New Zealand has so far experienced is expected to continue, in the longer term there are concerns that rising interest rates could begin to drag significantly on the Kiwi economy.
But perhaps the biggest test will be for the property market.
After seeing the median price of a residential property in New Zealand increase 28.7 per cent from $637,000 in June 2020 to $820,000 in June 2021, there are concerns about the impact rapidly rising rates may have.
According to one analysis by Interest.co.nz journalist David Hargreaves, if ANZ’s forecasts of 1.5 per cent in rate rises by November 2022 are realised, the monthly amount a first homebuyer must make in repayments on the median first homebuyer mortgage would rise by 17.5 per cent. Over the life of a 30-year loan, including expected interest costs and fees, that’s an increase of up to 78.9 per cent compared with what they are paying currently.
Interest rates in Australia
Despite their similarities, the RBA has a very different viewpoint on interest rates when contrasted with the RBNZ, particularly after the recent changes made by the New Zealand government to include housing prices in its mandate.
However, the fact remains that conditions are changing rapidly and this could cause the RBA to raise rates years earlier than expected.
Prior to the lockdowns in South Australia, NSW and Victoria, this is exactly what interest rate futures markets were pricing in.
According to an analysis done in early June by US investment bank J.P Morgan, the interest rate futures market expected around 0.4 per cent worth of rate rises over the next two years, 1 per cent over the next three years and roughly 1.5 per cent over the next four years.
Naturally the lockdowns and growing levels of uncertainty about the future of the economy will impact when the RBA will raise rates.
But if inflation continues to rapidly rise and spends a protracted period outside the RBA’s 2 per cent to 3 per cent target band, the RBA may be forced out of its supertanker style course into one more resembling its more agile sister across the Tasman.
Because as the world continues to grapple with the pandemic, government stimulus and their knock-on effects, any and all plausible outcomes are very much on the table.