Frank Newman: Interest rates to hit homeowners and businesses

2014 is likely to be a tough year for debt burdened home owners and businesses. As expected, last week the Governor of the Reserve Bank left the Official Cash Rate (OCR) unchanged at 2.5%. Of greater interest was his commentary.

The Governor has for some time warned borrowers that interest rates will rise. Last week he was more specific. The first of the interest rate increases is likely to be announced on 13 March 2014, and rise 1% (100 points) in 2014 and by 2.25% over the next two and a quarter years (through to mid-2016).

That means a family with a $200,000 mortgage is likely to be paying about $40 a week more in interest this time next year, and $85 a week by June 2016. 

There will also be an immediate, and potentially more severe impact on businesses. In my view the financing risks businesses currently face has been largely ignored by the Reserve Bank and central government, and gone unreported in the media.

A 2% interest rate increase would be the final straw for those businesses already operating on paper thin margins and battling declining sales. In 2014 a number of those businesses will have to do the inevitable: tell staff the money has run out, close the doors, and in many cases take a significant personal financial loss.

The Governor also had some interesting things to say about house prices generally.

“Contributing to rising house prices are low interest rates, a rise in net inward migration, and region-specific supply issues. These sources of support are expected to ease over the medium term…Further, restrictions on high loan-to-value (LVR) mortgage lending, introduced by the Reserve Bank in October, are expected to reduce annual house price inflation by between 1 and 4 percentage points over the next year.”

In other words, the factors that have causes property prices to rise are likely to ease, the LVR ratios will reduce house prices (by how much is uncertain) and higher interest rates will dampen housing demand. With those headwinds, property investors should not expect 2014 to be a vintage year for capital growth.

Although the LVR restrictions were only introduced in October (and have now been modified to exclude new builds), the general effect has been for banks to split the pricing of their mortgages, with low deposit borrowers paying a 0.5 percent interest rate premium (and additional fees).

The general pattern for borrowers has been to switch from floating to fixed rate mortgages. The Governor says, “At the end of October, the share of floating-rate mortgages was 43 percent compared to 56 percent a year ago. Most of the mortgage rate fixing has been for short terms, with the share of fixed mortgages up to a 1-year term at 30 percent.”

With 73 percent of borrowers on floating or short-term fixed rates the impact of rising interest rates on households will be immediate.

There are many other important dynamics ahead for 2014. The prediction market, iPredict.co.nz, offers interesting forecasts on a wide range of topics. Their predictions are based on the public making win or loss (binary) bets, which have proven to be more reliable than opinion polls. Offsetting the negatives above:

• The ipredict marketplace expects the economy to grow by 4% in 2014. This is higher than the Reserve Bank’s projection of 3%, then slowing in 2015.
  
• High dairy prices are likely to remain high. 61% predict the Fonterra pay-out per kg of milk solids to be above $8 at least until June 2015.
  
• Unemployment is expected to fall in 2014.
  
• There is an 82% probability the Government’s finances will return to surplus in the 2014 Budget.

On the political scene, iPredict says there is a 50% chance National will win the general election in November 2014. National is expected to gain 41% of the vote, Labour 35%, Greens 10%, Conservatives 5.7%, NZ First 4.6%, Maori Party 1.5%, and the others less than 1%. Maori, Mana and United are expected to win 1 electorate seat each. NZ First and ACT are not expected to win an electorate seat and would therefore be out of Parliament.

Interesting times ahead for 2014, and challenging times for those vulnerable to higher interest rates.