Sunday, June 14, 2015

Frank Newman: Interest rates and local property prices

There are some pretty seismic things happening in the finance markets at present. Last week the Reserve Bank lowered the Official Cash Rate (OCR) by 0.25% and signalled further reductions are possible (the reviews are six-weekly).

My translation of the smoke signals is that things are getting pretty dire in the farming sector. Within 12 months farmers' top line revenue has halved. That's a collapse in anyone's language. This would be manageable if it were a mere blip but price collapses rarely are, and it's now looking like international dairy prices may remain low into the medium term.

The fact that Fonterra has announced it will go through a "review and restructure" supports the view  that recovery will take longer than expected. Fonterra has other issues. In the long-term the establishment of Chinese owned milk processing plants here in NZ may threaten their share of the supply chain; farmers get as much or more for their milk and they don't need to tie up capital in Fonterra shares which could be sold to repay debt.

To protect farmer incomes and protect the economy from a shock, the people with their hands on the levers want a lower exchange rate so exporters receive more Kiwi dollars when they convert their now depreciated export earnings.

To do that they not only have to talk down the value of the Kiwi (which has not really worked to date) but make it less attractive for overseas investors putting money into our money market - hence reducing the OCR.

The 0.25% reduction on the 11th of June, and the commentary that further cuts are possible, had an immediate and desired effect. The Kiwi dollar fell by some 2 cents against the US dollar to just under 70 cents. Most experts expect it to go lower.

The major banks responded immediately by reducing floating mortgage rates (and deposit rates). The obvious risk is that it makes property investment more attractive, exacerbating an already hot Auckland property market - which the Reserve Bank claims is a risk to the economy as a whole.

This explains the policies in Budget 2015 to tighten the rules around the ‘intention’ test, and the move by the Reserve Bank two weeks earlier to make lending more restrictive in Auckland and less restrictive in the provinces.

How Auckland property prices react is debatable. My take on it is that prices will probably keep rising for a year or two then top out and flatten for quite a while. Supply is now catching up quickly and will turn into an over-supply.

Property investors see these trends long before the media report them so more are now buying in the provinces. Those cities within reasonably close proximity to Auckland are already seeing an investment migration: Hamilton, Tauranga, and Mount Maunganui in particular. Whangarei may become a favourite given it is now starting to emerge from a Rip van Winkle like sleep.

The provinces still offer rental yields greater than the mortgage interest rate. This is a pretty unique situation that usually does not persist for more than a few years. The latest mortgage rate cut has made the equation even more attractive.

The downside of a lower Kiwi dollar is that all imported goods and services (which are paid for in an overseas currency) become more expensive. About 30% of all goods and services (GDP) in New Zealand are imported. That makes us one of the most open economies in the world and vulnerable to exchange rate movements. The most obvious is petrol – the pump price may well be 10 to 20 cents a litre higher sometime soon. Ironically a lower Kiwi dollar will also inflate the cost of building materials, just at a time when the government is trying to make housing more affordable. 

The bottom line is the farm and forestry sectors will get some partial relief from their crisis, living costs will increase for everyone, savers will get less from their savings, borrowers will pay less in interest (which they should put into additional principal repayments), those selling goods and services overseas will earn more, the number of overseas tourists is likely to grow, and provincial property prices are likely to rise.


Brian said...

Interest Rates/PropertyPrices/OCR/ & (of course) AUCKLAND.
Yes, things are dire in the farming sector, but apart from a few highs in that sector such as the 1950’s wool bonanza and recently China buying up dairy produce; nothing much has changed. The boom last year in the Dairy commodities market coupled with the recent decline in over production by the EU and USA promoted a short termed bonanza.
Farmers have had to cope with being price takers in a New Zealand from day one, and the separation of the non export sector from facing these dire fluctuations is the real cause for concern. This internal sector cosseted and protected for decadesand even today by successive governments, is bound to the principal that elections cannot be won by insisting on any belt tightening by the general public. They have accepted without question that the answer to any inflation is to increase prices, and wages despite the hardship this produces on our export economy. Hence our governments whatever their political hue use high interest rates to keep the dollar at a false peak. The export sector being a very small insignificant factor at election time, can therefore be sacrificed without any measureable effect.
Apart from which, most New Zealanders, with the exception of the export sector have lived very comfortably on a cost plus economy; knowing full well that any political party who wishes to remain in power must continue along these lines.
For all intents and purposes, this present New Zealand “line” is similar to the one drawn in the sand on Greek beaches which we now see is being washed away leaving a mountain of debt. What will be left in our case will be a vast increase of an unaffordable bureaucracy, a debt borrowing to retain a standard of living that is not being earned, and a political system that relies solely on the future to pay the bill.
It has been quite obvious for some considerable time that there are two New Zealand’s, (actually there are three). We have the provinces and then Auckland; plus the third, the State Cocoon of Wellington. This was borne out in fact as Frank states, with the Reserve Bank making lending more restrictive in Auckland, which in reality was a step in the right direction although a very weak one; towards the acceptance that Auckland is different.
I think Frank is somewhat optimistic that Auckland house prices will flatten out (whatever that actually means), as it depends to a large extent on whether this Government or the next, is prepared to accelerate the building of houses and, at the same time, place some sensible curbs on both legal and illegal immigration. This maybe misplaced optimism, judging from the P.M. and Opposition benches and does not seem at all likely. Our Prime Minister is after all, no Mr Abbott.
Just how long the Government will factor in its own idea on a further reduction of interest rates that it can endure, without the inevitable demands from the battalions in the Trade Union sector forcing up wages to compensate is anyone’s guess. (Certainly it will never be in the vicinity of an election).
Farmers in the past have been resilient enough to withstand the enemy without, whether they can withstand the ever increasing enemy within, is quite another question?!!

Don said...

Brian, your comment on Frank's article was quite insightful. Townies unlike farmers live optimistic and often unrealistic lifestyles based on huge mortgages & revolving credit. I live in Auckland, am retired and face enormous rates rises, transport levy rises, fuel price rises, electricity price rises, etc, etc but am fortunately debt free. Our government lacks the backbone to limit migration, to direct migrants to other regions, to directly stimulate other regions to boost jobs there, etc. Tony Abbot's government is more courageous. One might hope that a more realistic ex businessman like Stephen Joyce might lead the Nats & look to more radically reform many of our tired conventions. Continuing in the same vein wont help, this country needs to add more value to commodities, so needs to stimulate R & D.

John in Kiwiland said...

Good comments here and Don had it absolutely correct that the Government should be prioritising investment, even relocation to the provinces. This would grow the regions and benefit Auckland whet er fewer young people will havr the urge to move to Auckland. Encourage migrants to go to the provinces will boost this regional development gor the benefit of the whole cpuntry but, in particular, Auckland.