Friday, January 31, 2014

Frank Newman: Low interest rate era to end

Yesterday the Governor of the Reserve Bank sent the strongest signal yet that the era of low interest rates is about to come to an end.

Graeme Wheeler said, New Zealand’s economic expansion has considerable momentum. Prices for New Zealand’s export commodities remain very high, especially for dairy products. Consumer and business confidence are strong and the rapid rise in net inward migration over the past year has added to consumption and housing demand. Construction activity is being lifted by the Canterbury rebuild and by work in Auckland to address the housing shortage. Continued fiscal consolidation will partly offset the strength in demand. GDP grew by 3.5 percent in the year to September, and growth is expected to continue around this rate over the coming year.”

In other words, the economy no longer needs to be propped up by low interest rates. Although Mr Wheeler left the Official Cash Rate (OCR) unchanged at 2.5% most economists are picking a 0.25% rise on the 14th of March, and the prediction market, iPredict, has the odds of a 0.25% rise in March at 78%.

This means those on floating interest rates are about to face interest rate hikes, while those locked in will be protected, but only until their loans come off fixed rate.

The ANZ expect the OCR to reach 3.5% by the end of this year, 4.25% by the end of next year, and 4.75 by the end of 2016. That, they believe, would see floating rates at 8% by the end of 2016. Rates were last that high in November 2008.

Returning interest rates to “normal” levels (their long-term average levels) over two years gives homeowners and investors plenty of time to adjust without getting spooked, and without inflicting a fatal injury to those with high debt.

At some point those on floating rates will switch back into fixed rate mortgages, although this is likely to be gradual rather than an immediate. It is likely “switchers” will favour whatever is the cheapest term on offer – and that’s likely to be short-term fixed rate mortgages – or go for special deals on offer.

There is no doubt the days of cheap money are about to end and that will have some cooling effect on property prices. We are about to enter a long-term phase of higher interest rates which will last decades rather than years. That will be good for those who rely on interest income. The downside is that higher interest rates may create a greater inflow of overseas capital into our money market, creating demand for the kiwi dollar and putting upward pressure on the exchange rate.

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