Friday, February 10, 2017

Frank Newman: Crystal ball gazing


In its first review statement of the year the Reserve Bank has left the official cash rate (OCR) unchanged at 1.75%. The commentary from bank governor Graeme Wheeler suggested it could remain at these levels for quite a while - years rather than months. He said inflation would be the major consideration when reviewing the OCR in the future but he does not expect inflation to track outside of the one to three percent band and is forecasting it will not reach two percent until some time in 2019.

That's good news generally but does not mean mortgage rates will remain unchanged. Banks finance a significant part of their lending from overseas and interest rate changes in those markets will flow through to mortgage rates here. Global interest rates are on the rise, and our mortgage rates have already increased about 0.5% from their lows.

Mr Wheeler said, "The long term outlook for mortgage rates will very much depend on what happens to long term interest rates and that will very much depend on what happens globally, but particularly in the US, and where the US goes with fiscal policy". In other words, it depends what Donald Trump does, and how others react.

The slow-down in house price inflation, particularly in Auckland, has prompted the new Minister of Finance, Steven Joyce, to express some cautionary words. Speaking to Parliament's Finance and Expenditure Committee, Mr Joyce urged those buying property to think about where interest rates will be in three or four years time.

He said, "There's not much upside in house prices….The bigger risk that people should just think about the potential for interest rates to rise in the years ahead - we're seeing that now in bond rates and that's why I think it's important people don't overextend themselves at this point…It's often in the case of economics that once people have something for a while, whether it's low oil prices, high oil prices, or low interest rates, they seem to assume it will last forever, but it doesn't."

At the time of making the OCR announcement, the Reserve Bank also released its quarterly Monetary Policy Statement, which is a commentary on a wide range of economic factors and is a useful pointer to what may lie ahead.

On migration the Reserve Bank says, "Weakness in the Australian labour market has contributed to high net immigration to New Zealand over the past three years, particularly through fewer New Zealand resident outflows to Australia. Net outflows to Australia are currently around zero, compared to historically averaging around 15,000 per year."

In other words, the 15,000 people who usually leave New Zealand every year to work in Australia, are staying home. The grass is greener on this side of the fence.

On house prices the Reserve Bank says, "Housing demand is expected to be supported by high net immigration and low mortgage interest rates. House price inflation is forecast to remain elevated through 2017 (figure 5.5), albeit lower than was expected in the November Statement ["Nov MPS"]. This is in part due to the recent increase in fixed-term mortgage rates. House price inflation is expected to slow beyond 2017, reflecting an easing in net immigration, greater housing supply, and affordability constraints becoming more binding." In other words, they expect a slow down in house price rises over the next two or three years.

They say higher mortgage rates and the tighter loan-to-value ratio (LVR) restrictions have already cooled the housing market. "The number of house sales nationwide has fallen by about 20 percent since its peak in April 2016, largely reflecting slowdowns in Auckland and surrounding regions…House price inflation has also slowed recently. This slowdown has been broad-based across regions. Nevertheless, annual house price inflation remains high by historical standards. House prices rose 13.7 percent over 2016, boosted by low mortgage interest rates, a shortage of housing, and continued high net immigration."

And on the outlook for exports… "New Zealand’s commodity export prices, particularly dairy prices, lifted through the latter half of 2016…We assume some of the increase in dairy prices is temporary, with whole milk powder prices trending back towards USD 3,000 per tonne over the medium term. However, assumed increases in the prices of New Zealand’s other exports see overall export prices trend higher." That's a cautionary word that dairy farmers should not expect a continued rise in their payout.

The Reserve Bank has restated its often restated view that the NZ dollar is overvalued. To date their comments have had no effect, and are unlikely to have any effect while our interest rates remain high by international standards. 

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