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Mild Interest Rates Expected

5 April 2002

Mild Interest Rates Expected As Banks “Take Back The Insurance”

The interest rate cycle in New Zealand and the US is expected to remain mild despite recent rises according to New Zealand’s largest fund manager, AMP Henderson Global Investors.

Head of investment strategy Paul Dyer characterised the current round of cash rate increases as central banks “taking back the insurance” of last year.

“In the wake of September 11 both the US Federal Reserve (Fed) and the Reserve Bank of NZ (RBNZ) effectively took out insurance by heavily cutting the cash rates,” said Mr Dyer.

“Now as global growth looks to be improving the banks are removing that insurance. Despite this we believe the interest rate cycle will remain mild. We expect New Zealand cash rates to peak at around 6.5 to 7%. “

The 90s showed that global economies with low inflation could slow or stimulating growth through modest interest rate changes. Thus in relatively boom conditions the Australians only needed to raise rates from 4.75% to 7.5% in 1994/95, before reverting to monetary easing. Similarly in the financial crisis of 1998 a reduction of just 0.75% in interest rates by the Fed helped avert a broad economic slowdown.

“Over the past decade wholesale cash rates in New Zealand have ranged between 4% and 10%. We are unlikely to witness anything like this range over the next decade. While interest rates will certainly rise over the next year, we believe the magnitude will be modest.”

This has three implications for New Zealand investors.

“First, bond yields are likely to continue to move up until cash rates peak. However, markets are becoming highly anticipatory of Central Bank moves. Thus we saw yields peak in early 2000, almost a year before the first interest rate cuts. Currently yield curves are at near record steepness in many economies, including New Zealand. This suggests that while fixed interest returns have been poor over the past six months, the worst may already have passed.”

“Second, share markets are likely to rise further based on stronger earnings and the largely neutral monetary policy. Last year we saw strong gains from most local shares driven by falling interest rates. This stimulus is over but is being replaced by rising earnings expectations. It’s also apparent that those sectors likely to benefit from sustained economic growth such as the Ports, have tended to be the better performers.”

“Last, the New Zealand dollar is likely to continue to strengthen. Firming growth and interest rates in New Zealand are generally supportive of the currency. In addition, the US$ has risen against most currencies in recent years and is clearly over-valued. The US balance of payments position dictates a correction in the US$ at some point. “


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