ANALYSIS: Since the Reserve Bank cut the Official Cash Rate last week and signalled another 0.5% worth of cuts, we have seen some falls in wholesale interest rates. For instance, the one-year rate for banks has fallen from around 2.95% to 2.8%, while the three-year rate has dropped from 3.1% to around 3.02%.
Why haven’t wholesale interest rates fallen more? Partly it is because the markets know the Reserve Bank will almost certainly tighten its monetary policy again in the near future.
Interest rates move in cycles just as economies do, and borrowers at the moment need to be careful not to fall into the trap of thinking that borrowing costs won’t rise again.
In fact, rates are likely to rise faster as a result of the Reserve Bank’s generous comments last week. That’s because, by buying an extra stimulus to our economy now, the banks increased the risk of extra inflation once growth is chugging along at a good pace.
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Why can we be sure of that? Mainly because businesses have signalled that once customer numbers rise, they will take the opportunity to increase selling prices. Maybe Kiwis expect this, and that’s why the average year-ahead inflation expectation of households recorded in the ANZ Roy Morgan measure has risen to 5.1% from a recent low of 3.8% at the end of last year.
But it is not just the extra slight reduction in interest rates now which increases the chances of extra inflation come 2027 – the year after next. Fonterra has just sold its consumer brands businesses, and over $3 billion is to be returned to its farmer suppliers. That is about a 0.8% boost to GDP, which will first lift rural economies before feeding into the cities.
Despite beliefs that retail spending had shrunk during the June quarter, figures released this week show that retail spending actually rose 0.5% after adjusting for inflation and seasonal factors. The economy is not actually as weak as the Reserve Bank had thought. That means there won’t be as much inflation-suppressing spare capacity as it had anticipated.
Independent economist Tony Alexander: “Give thought to managing your interest rate risk by not fixing all of your debt for just one time period.” Photo / Fiona Goodall
None of these developments should worry borrowers. They just remind us that just as economies, inflation, and interest rates can surprise on the low side, so too do they surprise us on the high side at times as well. And of note here is that one inclusion in this statement is wrong. Inflation has not just surprised on the low side.
Our annual inflation rate is currently 2.7% despite the economy shrinking 1% in the year to March, the unemployment rate rising from 3.3% to 5.2%, and many businesses across numerous sectors closing their doors. Inflation actually looks like it will rise to just over 3% and that is problematic as we contemplate an improvement in demand in the economy next year.
For borrowers, all this adds up to is something mentioned here previously. Give thought to managing your interest rate risk by not fixing all of your debt for just one time period. Choosing two periods – like one and two years, or 18 and 36 months – can buy you time to adjust your budgets should an interest rate surprise come along, up or down.
https://www.oneroof.co.nz/news/tony-alexander-rates-are-going-to-rise-and-homeowners-need-to-buy-themselves-time-48028
– Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz