No Interest Rate Yet - Laymans Guide To MPS

For those without economics degrees this is a simple guide to something significant which happened in the world of economics today that has relevance to the person on the street.

NO INTEREST RATE YET

WHAT HAPPENED?

The Reserve Bank released their three monthly economic forecasts and reviewed the official cash rate which determines floating mortgage rates. They left the official cash rate (OCR) unchanged at the 5.75% level reached in July last year but noted that the next time they change the rate it is more likely to go down than up – but only if a rising exchange rate is accompanied by easing growth in areas like housing and the labour market. They note the NZ economy is continuing to perform well with growth still near 4%.

WHY DID THIS HAPPEN?

The Reserve Bank are charged with keeping inflation between 1% and 3% on average over the business cycle. They try to do this by speeding up the economy and the pace of price rises when inflation looks like getting close to 1%, and slowing the economy down when inflation is forecast to get near 3%. They have only one way of doing this – altering the official cash rate which banks must pay the Reserve Bank if they are short of funds in their account with the RB at the end of each day.

Raising the OCR for instance causes banks to try and reduce the chances of being caught short by borrowing more money from other banks, doing so by offering higher interest rates. This happens instantaneously if the OCR change is a surprise, but over a period of weeks of the change is widely anticipated. The higher bank to bank interest rates feed into mortgage and other interest rates, causing borrowers to cut back on debt growth and spending, slowing economic growth. Savings might rise as well.

The RB left the OCR unchanged in spite of falling export incomes which will cause NZ growth to slow to nearer 2.5% this year than 4.5% last for the following reasons.

- Labour shortages which will boost wages growth.
- Booming construction lifting construction costs.
- Still high inflation near 4% in the domestic (non-export/import) part of the NZ economy.

WHO IS AFFECTED AND HOW?

Borrowers because they will have to wait a tad longer before their floating interest rates decline – if they do this year.
Exporters because the signal of a rate cut not being imminent was less hopeful than had been expected in the markets, and this will reinforce expectations of continued firm interest rate support for the NZ dollar.
The housing industry because all involved will take heart from the absence of any sign that interest rates are going to go up anytime soon in spite of the housing surge.

WILL THIS CONTINUE?

We rate the chances of an OCR cut this year at 50:50. The local economy is being well supported by strong net inward migration and already low interest rates, so there is only minimal risk of inflation falling to near 1% in the medium term. But if we had to get off the fence would forecast a 0.5% cut by June, taking floating mortgage rates to near 7.35% from 7.85% currently. A cut is not guaranteed.

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