John Paine: June Finance Newsletter
The Reserve Bank's Official Cash Rate is due for review on Thursday and no change is anticipated - so expect little change in floating interest rates, if any.
But as I've been predicting for some time now, fixed interest rates have been creeping up - with most bank and non-bank residential rates increasing since I wrote last month's newsletter.
Whether or not there will be any more increases will depend largely on what happens with offshore rates. And this is hard to read. The latest set of minutes from US Federal Reserve policy-makers has left markets with no clear idea as to the central bank's interest rate strategy.
Inflation expectations are the key. Inflationary pressures are building worldwide, and core inflation is beginning to creep upward in many of the world's key economies. Despite some recent softening, prices of commodities - including oil prices - remain near record levels. To date the impact on core inflation has been quite subdued. However, this seems about to change.
Wage inflation has begun to accelerate in the U.S. and core inflation is edging up. This means that the global monetary tightening cycle is not over. According to a recent report from the international forecasting company Global Insight, a year from now both short-term and long-term interest rates are likely to be 0.50% to 1.00% higher than current levels.
"In response to rising inflationary concerns and central bank tightening, global bond yields are moving up, bringing an end to the 'conundrum' of low long-term interest rates" they said.
Here it seems wage inflation is accelerating and the lower dollar and higher oil prices must eventually creep into the Consumer Price Index. Inflation here looks more and more like encroaching on 4% and may well pass this figure by the end of the year.
So expect a strong statement from the RBNZ on Thursday and little chance of a reduction in the Official Cash Rate this year.
While there's differing opinions amongst economists I'm still of the view floating rates will not decline sharply and borrowers should fix for 2 or 3 years.
In May the cash rates in Australia, the U.S. and Canada all increased by 0.25% to 5.75%, 5.00% and 4.25% respectively. Here it's 7.25% and while we still have a premium over other OECD countries, the gap continues to narrow.
Accordingly country risk is becoming more a factor. For example Australia's economy is booming with the rise in commodity prices while New Zealand's economy stagnates - see last month's newsletter.
So where is the New Zealand dollar headed?
A key issue will be the Eurokiwi and Uridashi maturities coming up. An excellent chart put out by First NZ Capital shows the crunch coming in the September to December 2007 quarter. Maturities in December this year are near to $1,500 million but in September and November 2007 they are around $$3,500 million. That's big!
The Belgian dentists and Japanese housewives may be saying the 0.50% interest rate difference between the here and Australia is not worth the currency risk. Will they re-invest? Who knows - but if they don't you'd expect the capital outflows to severely knock our currency.
Reading the predictions of most economists and commentators it looks as though by mid 2007 the NZD will be in the USD 53 - 55 cent range and AUD 75 - 77 cent range.
On one thing all agree - it's going to continue to drop.
The volatility of our currency makes it very difficult for exporters. A recent study shows New Zealand had one of the most volatile currencies and, interestingly enough, Australia one of the most stable. From its low in December 1991 the Trade Weighted New Zealand dollar rose 31% to an April 1997 high, fell 32% to an October 2000 low, rose 55% to a November 2005 high and has fallen 15% since then.
Our future lies not with traditional exporting businesses that cannot compete with low labour costs overseas - and die when our dollar is high - but with the rapidly growing number of businesses here that provide specialised and innovative products and services aimed almost entirely at offshore markets. Fisher & Paykel Healthcare is a classic example of this.
Meanwhile we're hearing the New Zealand housing market is pulling back - but statistics and anecdotal evidence indicate this is far from severe. In any event the rise has been so strong since it started in 2001, I suspect it's mainly speculators and those highly leveraged at lower fixed rates who will feel the pinch.
ASB put out a very good paper last month analysing the housing trends and comparing them with previous slowdowns. The key points I derived from this were:
* The number of sales peaked in 2003, declined in 2004, slipped further in 2005 and dropped sharply in early this year. But the average number of sales is slightly above the average of the previous 10 years. In other words house sales are slower but not slow.
* The nationwide median house price continues to increase but price increases have slowed markedly and vary considerably in different regions. No longer can a buyer expect the value of their house to increase as a mater of course. Since 2001 average house prices have increased by 89% - a huge increase both in absolute terms and relative to such measures as income and rents.
* These huge gains are not out of order with those that have occurred in other parts of the world in recent years. The Economist lists New Zealand in the middle of their 20 country survey, with the 1997 - 2005 average house price changes ranging from large gains in South Africa (+ 279%) to large falls in Japan (- 30%) and Hong Kong (- 45%).
* The number of days to sell a house is increasing - but it's still shorter than the average time to sell over the last several years.
* The lagged impact of rising interest rates over the last two years is yet to be felt. There was $41 million residential debt - 36% of total debt - at the end of February that will roll off fixed rate terms over the following 12 months. The average rate paid on this debt was 7.31% per annum. When rolling into a new fixed rate loan the rate could be over 8.0% for many.
* There is potentially an overhang of houses and sections following the large scale of property development in the last three years.
Their paper then drew from the experience in Australia where the housing cycle has already experienced a slower phase after prices peaked in a number of centres around late 2003 to early 2004.
The results were remarkably similar to the 1998 - 2000 experience here where price falls of 10% were not unusual and the time to surpass previous price peaks can be long with different regions varying considerably. In some cases sharp price falls can occur and it may take a long time before prices rise to previous heights.
In my view apartments and "coastal" holiday sections that aren't really "on the beach" are particularly vulnerable.
John Paine B.Sc. Dip BIA Global Pacific Corporation Limited P O Box 3229,
Auckland, New Zealand
Please note that all opinions and statements expressed in this newsletter are indicative of my opinion only. Global Pacific Corporation Limited issues no invitation to rely on the information contained in this newsletter and intends by this statement to exclude liability for any such opinion and statement.