John Paine - August Finance Newsletter
Rising inflation, oil prices and interest rates continue to dominate the world economic news. Financial markets are extremely volatile.
Last week the New Zealand Reserve Banks kept the Official Cash Rate at 7.25%, while earlier in the month the Australian Reserve Bank kept theirs at 5.75%. Both moves were expected by economists and commentators.
There were however some not so subtle differences in the statements accompanying the announcements here and in Australia.
Here Reserve Bank governor Alan Bollard said "We do not expect to have to tighten the OCR further in this cycle", but also said "it will be some time before an easing in the OCR can be considered." It looks like any cuts are now at least nine months away - and more likely a year.
Some economists believe inflation here is a real threat and the New Zealand Reserve Bank has only a short time to get it under control before the next election. There is a growing school of thought that a further rate rise in the OCR is possible.
Over the Tasman economists believe the Reserve Bank of Australia will lift their cash rate to 6% next Wednesday, and once more again this year, as news came through that Australian annual inflation had hit 4%. This is the highest since the 1995 December quarter. It's already 4% here.
The narrowing interest rate gap means we can expect the exchange rates between our two countries to widen as investors sell out of New Zealand dollars and buy Australian dollars backed by a stronger economy driven by the commodity boom. This could be bad news for our dollar with all the Uridashis and Eurokiwis about to mature - to see my June newsletter on this subject
Over the last couple of weeks the NZD/AUD registered some of its largest falls and will remain under pressure for the reasons given above.
Meanwhile U.S. Federal Reserve Chairman Ben Bernanke has issued warnings that stubbornly high inflation could harm the U.S. economy. He said the economy appeared to be "in a period of transition" to more moderate growth from the swift advances earlier in the year.
The Federal Reserve has raised benchmark overnight borrowing costs to 5.25% in 17 small steps dating back to June 2004 and he said he saw "significant uncertainty" about federal funds rate policy going forward. It looks like the jury's still out on whether the Fed will pause when it meets on the 9h of August our time. Their base rate is now at its highest level in more than five years.
As we predicted - and have seen - fixed mortgage rates here have increased and broken through the 8% barrier. 1 and 2 year rates are now in the 7.85% - 8.9% range. The 5 year rates are currently the lowest and range between 7.65% and 8.36% - I recommended fixing longer in last month's newsletter.
The increased rates are now starting to bite and will slow the housing market and the economy further as more and more fixed mortgages mature.
According to a recent ANZ Bank Market Focus, $40.7 billion or 43% of existing fixed rate mortgages will become due for renewal in the next 12 months - the bulk in the period October to December. The weighted average interest rate of these is 7.45% so borrowers are facing a rise of 0.5% to 1% on current rates. And this could be higher if global rates continue to rise further.
Add the increased price of petrol - you do notice it don't you - higher local authority rates on houses, and higher power costs to name a few, and one would have to expect a slowing in the housing market and consumer spending.
Yes, the housing market. Everywhere I look economists are saying globally, the housing markets are cooling. But are they?
In Australia real estate is booming again. A rush in sales has increased lending to home owners by 24% in a year. Borrowing by owner occupiers to buy existing homes is now 29% higher than the peak of the 2003 boom. Investors have also returned to the market with mortgage lending up 21% in nine months.
Taking what might be an extreme example of sale prices, in one street in Mermaid Beach on the Gold Coast, a house on 920 square metres of land recently sold for A$24.5 million, the owner of a house 10 down the street turned down A$50 million, and duplex houses on the beach - three level, 450 square metres on 405 square metres of land - sell for between $9 and $13 million.
Sales of new homes in the U.S. declined 11.1% in the year to June and prices dropped 1.5%. But home prices in the first quarter of 2006 were 12.5% higher than a year earlier.
We're told housing markets in Europe are slowing down too. But there house prices are expected to rise by about 7.5% this year, after increasing 8.8% in each of the last two years.
Here in New Zeland building consents were down 7.3% on the June year. But the national median price of all home sales at $310,000 is still up 8.8% on a year ago. Nationally average house prices were up 11.5% in June compared with June last year, less than the 12.4% gain in May, and the large 16.8% growth in January.
The OECD estimates housing prices in industrial countries have doubled in real terms in a decade.
Note we're seeing a easing in the growth of house prices - not an easing in the prices themselves.
A very good article out of the U.S by Market Watch real estate editor Steve Kerch sums it up pretty well. Because growth in housing has been so strong over the last four years, it's easy to say it's all going to be over and gone in fairly short order.
"But that thinking", he says, "ignores all the reasons that housing is still a good investment today and why regular people, not the speculators, will continue to buy in the months and years ahead."
"The return on a house isn't always that grand. But over the years, the average house in the United States has appreciated at a rate about 1.5 percentage points above inflation. Coupled with the enforced savings that paying down a mortgage brings, that has provided a solid nest egg for millions."
He goes on to say no one is yet sure what the complete fallout will be from all of the exotic mortgages that have been originated in the last four years.
I've already expressed my concern about the ease of raising residential finance in New Zealand with high lending ratios and "low doc" loans - to see my previous newsletter on this subject Click below.
Meanwhile the commercial and industrial property market continues to ignore all signs of a slowing economy.
The Property Council of New Zealand reported that in the year to March 2006 investors in commercial property enjoyed an average return of 18.44% up from 16.69% the year before. Much of this was driven by the increase in capital values - income returns remaining steady at 9.05%.
Yields - rental return divided by the price paid for the property - continue to be at 10 year lows. In Auckland prime office yields and industrial are below 8% compared to a 10% - 12% range during most of the last decade.
The demand is being driven by:
* a lack of alternative investment in volatile financial markets, * high cost of construction of new buildings,
* shortage of suitably zoned land,
* a stifling resource consent process,
* high employment and low vacancy rates,
* compulsory Australian superannuation funds looking for a home, * tax free capital gains on resale,
* and a world flush with cheap money.
While some of the yields commercial property sales are achieving look dangerously low at times when inflation and interest rates are on the rise, well located commercial property still looks to be the best investment into the foreseeable future.
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.