Reserve Bank Governor Dr Alan Bollard said:

The outlook for the New Zealand economy has improved since the publication of the March Statement.

Economic activity has been significantly disrupted by the Christchurch earthquake. However, while many firms and households – particularly within Canterbury – continue to be adversely affected, it appears the negative confidence effect of the earthquake on economic activity throughout the rest of the country has been limited.

The early signs of recovery noted in the March Statement have continued. Despite some continuing signs of weakness in the world economy, commodity prices remain very strong and firms expect to increase their hiring and capital investment. Reconstruction in Canterbury is projected to add about 2 percentage points to GDP growth over 2012, and boost the level of activity for several years thereafter.

Despite the strong outlook for export earnings, household expenditure is expected to grow only modestly. Household debt remains very high and is expected to constrain retail spending and the housing market for some time. Continued fiscal consolidation will also act to dampen activity.

The New Zealand dollar has appreciated substantially over the past two months. This appreciation, supported by high export prices for primary producers, is negatively affecting other parts of the tradable sector, constraining rebalancing of the New Zealand economy.

Headline inflation is currently being boosted by recent increases in indirect taxes, food and petrol prices, and surveyed expectations of future inflation have edged up. Despite this, indicators of capacity usage and core inflation suggest underlying inflation remains constrained.

As GDP growth picks up, underlying inflation is expected to rise. A gradual increase in the OCR over the next two years will be required to offset this, such that CPI inflation tracks close to the midpoint of the target band over the latter part of the projection. The pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold.”

 

1. Interest rate changes
2. Insurance premium increases
3. Government policy/tax changes

1) Interest rate changes

Looking at the latest home loan rates at http://www.mortgagerates.co.nz/ you will note that there have been price movements this afternoon.  ANZ and their sister bank National Bank were the first to cut rates reducing one-year rates by 50 basis points, 18-month rates have dropped by 26 points and its two and three-year rates have fallen by 16 and 11 points respectively.  This was followed by cuts to short and medium term interest rates by ASB and their boutique sister bank, Bank Direct, Westpac and TSB Bank. This earthquake is a game changer and all previous predictions are off.  Our GDP forecast for the year was 2.3% now it has been reduced to a tiny 0.3%.  The Canterbury region which Christchurch dominates is responsible for 15% of New Zealand’s GDP. It will struggle to be anywhere like as productive as it should be, and massive Government subsidies will be required. I now predict the OCR will be lowered by 0.50% on 10 March as an emergency measure to return it to its lowest point in 40 years.  This is what the market is predicting anyway, with the flow off into short and medium term interest rates.  Take a look at the following table:

Source: Interest.co.nz - Interest Rates at 1 March 2011

2) Insurance Costs

EQC Levies

Firstly I need to tidy up the misconception that after a natural disaster everyone is entitled to a payout from the Earthquake Commission (“EQC”).  This government body was set up under the Earthquake Commission Act 1993, to provide a natural disaster fund for homeowners and tenants who hold insurance.  The levies are 5 cents (plus GST) for every $100 insured, raised from landlord’s taking out building cover and tenant’s taking out contents cover.  The most you can pay a year for one dwelling and its contents is $67.50 including GST. This will give you the maximum cover of $100,000 (+ GST) for your home and $20,000 (+ GST) for personal belongings. EQC pays the value of  damaged land at the time of the earthquake or natural disaster, or the repair cost, whichever is lower.

Dwellings are covered on a replacement value basis. Personal property is insured on the same basis as the household insurance policy covering the same property.  Some retaining walls are covered, but on an indemnity basis.

Clearly this is going to be a massive claim on the EQC and although costs have not been calculated with claims deadlines for aftershocks to the 4 September 2010 not being closed yet.  It may well be the the EQC war chest is emptied and that the Government needs to borrow funds to top it up.  Going forwards EQC levies are likely to triple and you need to budget for this cost increase.

Insurance Premiums

Private insurers and their re-insurers are going to get hit hard in the pocket.  This is concerning to property investors as insurance costs were already going up in light of GST rises and increased claims in New Zealand as a result of the 4 September 2010 Canterbury earthquake – now general property insurance premiums will be much higher too.

3) Downstream costs from Government Policy

There has been talk by the Minister of Finance Dr Bill English today of removing the middle class tax relief that is Working for Families tax credits; and removing interest-free student loans. This will restore the policy to how I had in the 1990s at Auckland University where I could get my fees and course costs paid with a low interest rate (from memory it was just under the banks floating rates).  If we borrow too much it will put our plan to get to a Government surplus by 2014/15 into jeopardy prejudicing further Government spending or tax cuts.

Despite some data turning out weaker than projected, the medium-term outlook for the New Zealand economy remains broadly in line with that assumed at the time of the SeptemberMonetary Policy Statement.

Downside risks to the outlook for global growth continue, with high public and private debt inhibiting recovery in many developed economies. Moreover, it is unclear how further policy support would impact on the outlook for growth in our Western trading partners. Offsetting this weakness, strong growth continues in China, Australia and emerging Asia.

“Domestically, recent data has turned out weaker than projected. Continued household caution has seen consumer spending and housing market activity remain muted, and many firms have become less optimistic about their future prospects. However, continued high export prices, along with reconstruction and repairs in Canterbury, will support activity over the coming year.

Overall, continued GDP growth is expected to gradually absorb current surplus capacity over the next few years. Headline inflation is expected to move higher following the recent increase in the rate of GST. The subdued state of domestic demand suggests this inflation spike will have limited impact on medium-term inflation expectations.

While it is appropriate to keep the OCR on hold today, it remains likely that further removal of monetary policy support will be required at some stage.”

Source: Reserve Bank announcement 28 October 2010 - http://reservebank.govt.nz/news/2010/4216773.html

My Interpretation and Thoughts on the Announcement

Lets look briefly at the global macroeconomic factors in this environment of fear and uncertainty.  What exactly will happen in light of the second round of Quantitative Easing by the American Government (and to a lesser extent the European Central Bank and Bank of England) where they will be printing trillions of dollars to encourage spending, devalue their currency and retire debts?  Is China going to finally slow down its outstanding >9% year on year growth in its Gross Domestic Product causing major damage to commodity based currencies like the Aussie and Kiwi Dollars?  If Asian countries (particularly China and India) import less from New Zealand then we will have an issue and our long road to recovery will be quicker.

Inflation is something the Reserve Bank must control.  The historically high levels of unemployment unfortunately are not a prime consideration to the Reserve Bank.  Therefore they are likely to raise the OCR on 10 March 2011 to 3.25%, and a bit of crystal ball gazing this far out but again on 28 July 2011 to 3.50%,  on 27 October 2011 to 3.75% and then on 26 January 2012 to 4.00%.  This means that I am a fan of the two and three year fixed rates at present, particularly if you can negotiate a slight discount on them.

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Reserve Bank Governor - Dr Alan Bollard (source: www.scoop.co.nz)

While the global and domestic economies continue to recover, the outlook has weakened since our June Statement. We consider it appropriate at this point to keep the OCR on hold.

The earthquake that struck Canterbury on 4 September has significantly disrupted economic activity and is likely to continue to do so for some time yet. Many homes and businesses have been damaged, as have significant parts of Canterbury’s public infrastructure. Eventual reconstruction and repairs will require considerable resources over the next year or two, particularly in the construction sector. If, in the aftermath of the earthquake, the prices of some goods and services increase temporarily, monetary policy would remain focused on the medium-term trend in inflation. The Policy Targets Agreement explicitly instructs the Bank to look through temporary price increases generated by a natural disaster.

Looking more generally at the domestic economy, the household sector remains cautious, with consumer spending soft, house sales falling and house prices remaining flat. With continued soft demand for credit, this suggests household spending will not increase to the extent previously projected.

The pace of expansion in the global economy appears to have slowed in recent months with forward indicators of US growth, in particular, deteriorating noticeably. Nevertheless, continued strong growth in Australia and China will support demand for New Zealand exports, reinforcing the continued contribution of high export commodity prices.

Overall, despite the weakened outlook, we still expect that growth will progressively absorb current surplus capacity over the next few years. In addition, changes to indirect taxes and earthquake impacts will cause headline inflation to spike higher over the coming year. Previous experience of GST increases, the fact that annual CPI inflation has been near 2 percent for the past year and a half, and the subdued state of domestic demand suggest this inflation spike will have little impact on medium-term inflation expectations.

Over time, it is likely that further removal of monetary policy support will be required. The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement.”

The Forex markets treated this result strongly with the NZD:USD currency pair being slashed by 0.8 cents in the couple of hours post the announcement, before regaining a small part of this loss.  Dr Bollard went on to say that he thinks the peak of the OCR rises this interest rate cycle will be at 4.70%, and there are still a number of pressures on New Zealand’s economy so growth and our economic recovery are very slow. As a result we can interpret this by saying that with rising unemployment and other pressures in terms of more deleveraging to come, interest rates are likely to stay lower for a while to come, asset prices are likely to stay lower for a longer period of time, credit is still difficult to get, businesses, farms and individuals are still reluctant to borrow and spend money.

There will still be more mortgagee sales to come, and vendors in many areas need to get real and stop listing their properties for too high amounts (some agents are buying listings as they are desperate to get listing which such a low volume of sales) if they want them to sell anytime soon.  I know that there are people wanting to sell who are not able to as they would be in negative equity and unable to discharge their mortgages, or not wanting to sell as they believe (rightly so in my considered opinion) in the medium and long term that they will get a much better price.  Combined with the difficulty many purchasers have in raising finance with the current tough credit criteria, and probably more significantly a general reluctance to take on debt and instead choosing to ‘save and prosper’, we will have far less listings and sales, and many areas not getting much net migration will continue to go slightly backwards slowly but surely.

For property investors, the bad news is:

• depreciation cuts come in shortly on 1 April 2011,
• finance is harder to get (for many investors with larger property portfolios),
• GST rises kick in on 1 October affecting rates, repairs & maintenance and management fees, and
• house prices aren’t bolting up any time soon.

The good news for property investors is:

• rents are going up,
• surveys from the New Zealand Property Investors’ Federation state that tenants expect rents to go up,
• interest rates will stay lower for longer,
• interest rates are not expected to be where they were in 2008 (9.x% fixed, over 10.5% floating) in the foreseeable future,
• the sun will rise tomorrow, the day after tomorrow and every day after that – property values will rise in the long-term,
• there are some good positive cashflow properties available in main cities right now.

Source: Reserve Bank Website – http://rbnz.govt.nz/news/2010/4182378.html

Dr Bollard’s press statement interestingly said that:

the New Zealand economy continues to recover…

The economy is being assisted by both monetary and fiscal policy support…

If the economy continues to recover in line with our December projections, we would expect to begin removing policy stimulus around the middle of 2010.”

As a result I predict that the major banks will not change their floating rates, but perhaps edge up their 1 – 3 year rates a little bit further.  The floating rates will rise when the OCR rises.  I predict that the OCR will stay unchanged on March 11, April 29, but then rise by 0.25% on 10 June 2010.

Members should take note that the Reserve Bank today (30 April 2009) reduced New Zealand’s Official Cash Rate (OCR) from 3.0% to 2.5%, with Reserve Bank Governor Alan Bollard commenting:

“Overall, developments since March point to lower medium-term inflation than previously projected. The main factors behind this are weaker global growth, and an unwarranted tightening in financial conditions via both higher long-term interest rates and a stronger exchange rate than expected.  Global financial markets have showed some tentative signs of stabilisation since the March Monetary Policy Statement and governments in the major economies are continuing to make progress in resolving their banking system difficulties. However, a large amount still needs to be done and sentiment remains fragile. Negative feedback from the global recession could also still adversely affect financial institutions. The world economy deteriorated further than expected in the first quarter of 2009. While monetary and fiscal policy responses in many countries have been substantial and there are some signs of stabilisation in some countries, we still expect the adverse economic forces generated by the crisis to remain dominant throughout 2009. The timing and extent of global recovery remain highly uncertain. While the New Zealand economy has not experienced the same extreme falls in economic activity as seen in a number of our trading partners, it remains weak. Business sentiment is low, investment has been curtailed and employment reduced. We expect the large decline in the OCR over the past year to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing. This, together with the stimulus from fiscal policy, will act to support the New Zealand economy and eventually see activity trough and pick up thereafter. However, the scale of the global financial crisis and domestic adjustments underway are such that it is likely to be some time before economic activity returns to robust and healthy levels.

We consider it appropriate to provide further policy stimulus to the economy. We expect to keep the OCR at or below the current level through until the latter part of 2010. The OCR could still move modestly lower over the coming quarters.”

We have seen numerous cuts since the OCR peak in this interest rate cycle at 8.25% where it stood for a year until 24 July 2008.  This year we have had 2% cut off it alone with the 12 March policy announcement being a 0.5% cut, and the January 29 policy announcement being an unprecedented 1.5% cut.  The encouraging words from Dr Bollard are that there are “more in the pipeline” indicates a far deeper recession than previously contemplated, so like other Central Banks in the world he will try to stimulate the our economy with lower interest rates for business and household lenders.  This will flow onto lower interest rates for investors.  Other Reserve Bank heavyweights Tim Hampton and John McDermott were also present answering questions with Dr Bollard.  Sometime they mentioned which is important to consider is that to be competitive in International Captial Markets we can’t be like the US Federal Reserve, Canadian Reserve Bank and Bank of England who have 0.5% of lower equivalents to the Official Cash Rate.  I am predicting at this early stage only a 0.25% cut in the OCR at the next 6 weekly policy announcement on 11 June 2009, which is also where the 3 monthly Monetary Policy Statement will be presented.

While the New Zealand economy has not experienced the same extreme falls in economic activity as seen in a number of our trading partners, it remains weak. Business sentiment is low, investment has been curtailed and employment reduced. We expect the large decline in the OCR over the past year to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing. This, together with the stimulus from fiscal policy, will act to support the New Zealand economy and eventually see activity trough and pick up thereafter. However, the scale of the global financial crisis and domestic adjustments underway are such that it is likely to be some time before economic activity returns to robust and healthy levels.
Dr Bollard stated that “we consider it appropriate to provide further policy stimulus to the economy. We expect to keep the OCR at or below the current level through until the latter part of 2010. The OCR could still move modestly lower over the coming quarters.”

We have seen numerous cuts since the OCR peak in this interest rate cycle at 8.25% where it stood for a year until 24 July 2008.  This year we have had 2% cut off it alone with the 12 March policy announcement being a 0.5% cut, and the January 29 policy announcement being an unprecedented 1.5% cut.  The encouraging words from Dr Bollard are that there are “more in the pipeline” indicates a far deeper recession than previously contemplated, so like other Central Banks in the world he will try to stimulate the our economy with lower interest rates for business and household lenders.  This will flow onto lower interest rates for investors.  Other Reserve Bank heavyweights Tim Hampton and John McDermott were also present answering questions with Dr Bollard.  Sometime they mentioned which is important to consider is that to be competitive in International Captial Markets we can’t be like the US Federal Reserve, Canadian Reserve Bank and Bank of England who have 0.5% of lower equivalents to the Official Cash Rate.  I am predicting at this early stage a final 0.25% cut to the OCR in this economic cycle at the next 6 weekly policy announcement on 11 June 2009, which is also when the 3 monthly Monetary Policy Statement will be presented.

Westpac have already slashed 0.4% off their 6 month rate, and I understand all major lenders are reviewing their interest rates today.  The effect of this announcement is likely to pull down the floating, 6 month, 1 year rates, and 2 year fixed term rates and perhaps a trimming to the 3 year rate, as Dr Bollard in an unusual move suggested that the rates would remain low until at least the end of next year.  This strongly implies for the next 18 months that rates will not rise from where they are now.  Expect to see more cuts to the short term fixed rates and floating rates from various lenders today!

What Should I Do About This?
I would encourage all members to review their current loan portfolio and to work out an interest rate and loan strategy with their brokers or bankers.  It will be interesting to watch good sites like http://www.goodreturns.co.nz/mortgage-rates.html to get up to date interest rates, and www.sorted.org.nz to see the reaction to the Reserve Bank’s move to state they expect interest rates to be low until the end of 2010.  This move was possibly learned from the Reserve Bank of Canada where they found a way to impact longer term fixed rates (which Dr Bollard is frustrated by them rising).  In an unorthodox move they stated that they would not raise the OCR until at least the 2nd quarter of 2010.  We have implied no rise in the OCR at least from current levels until the end of 2010.  Watch and hope for medium term interest rates to fall with this significant level of certainty.

Interest costs are typically the greatest expense for property investors, so I look forward to hearing from the Deputy Reserve Bank Governor Dr John McDermott at the Auckland Property Investors’ Association meeting in July this year.  It will be great to understand where various interest rates are heading and why.