John Paine: February Finance Newsletter 2007
Last Friday the European Central Bank kept its key interest rate on hold at 3.5% but said “strong vigilance” was needed to avoid “risks to price stability”. Rates were last raised in December 2006 and economists there are now predicting a rate rise in March.
The same day the Bank of England’s Monetary Policy Committee voted to maintain the official Bank Rate at 5.25%. The previous change was a (surprise) increase of 0.25% on 11 January.
Last Wednesday the Reserve Bank of Australia left their cash rate unchanged at 6.25%. The last time official interest rates were raised there was in November 2006. Commentators are expecting no more rises – but no drop either until late this year. The Reserve Bank of New Zealand’s next interest rate review is not until 8 March. In its January statement - when the Bank left rates on hold - Governor Allan Bollard said “While the near-term inflation outlook is relatively benign, we remain concerned about the upside risks to medium-term inflation. In particular, our assumption that the housing market and consumer demand will resume their slowing trend over 2007 and 2008 is looking more uncertain, particularly if further fiscal expansion occurs.”
So what will they do with the Official Cash Rate in March?
Well, all the signs are there should be an increase due to:
* Rising pay rates. Latest figures from Statistics New Zealand show for the December quarter an average increase for all salary and wages of 5.5%. This is the largest quarterly increase since the index began in 1992. The rise for the December year is 3.2%.
* Much of the increase in wages is being attributed to labour shortages. A slight drop in employment of only 0.1% for the December quarter has the unemployment rate at 3.8% - well below the long run average of 6.3%. The labour market is still tight as a drum. By the way, in Australia the unemployment rate is 4.5% - a new 30 year low.
* Immigration is strong. Annual net migration into New Zealand to December 2006 is 14,610 – up from 6,970 for 2005. This will put more pressure on the housing market. The fact that the International Travel website rates New Zealand as the 4th best out of 193 countries to live certainly won’t discourage immigration. To see this article CTRL + click here http://www.internationalliving.com/issues/2007/2007_article.html
* House price inflation is running at 10%. The ASB’s housing confidence survey showed a net 43% of respondents thought house prices would continue to rise – up from a net 20% for the October survey. Statistics show the housing market has picked up at the end of 2006. The housing market seems to have found a third wind. These results will be of concern to the Reserve Bank.
* The ANZ World Commodity Price Index is up 1.3% in January following a 3.8% increase in December. Dairy prices were the main contributor. This has helped offset the negative effect of the high New Zealand dollar. But people are questioning how high commodity prices can go or how long the high prices will last.
Housing inflation is clearly a concern for all central bankers and a major reason for interest rate rises in the developed world. Here in New Zealand the concern is not restricted to the Reserve Bank.
* Affordability is now stretched. The recent study by Demographia found that of the 159 major urban markets in the U.K., Ireland, the U.S., Canada, Australia and New Zealand, 42 were affordable, 36 moderately unaffordable, 22 seriously unaffordable and 59 severely unaffordable. All 3 major urban markets in New Zealand fall into the severely unaffordable category. Interestingly enough the authors say high land prices resulting from government bureaucracy is a major part of the problem.
To see this article CTRL + click here http://www.demographia.com/dhi-ix2005q3.pdf I think they’ve got a point. Between 1981 and 2004 land prices rose 286% in real terms. If it hadn’t been for that growth house prices would have risen 16.4% over the 23 year period - instead of the 105% they have actually increased. Of course the high cost of materials resulting from a virtual monopoly here hasn’t helped the cost of building them.
* Senior BNZ economist Craig Ebert has written an article saying serious questions need to be asked about debt servicing current housing and farm values in relation to incomes. In the March 2006 year the proportion of income devoted to servicing debt was 13.1% compared with 7.8% in 2001 and 7.5% in the mid-1990s housing peak. see
I’ve written before about the problem the Reserve Bank has in reducing inflation by raising the Official Cash Rate. Most house mortgages have a fixed interest rate and are not immediately affected by an increase in the OCR. Michael Cullen has been making noises about a mortgage levy to slow down the housing market. This is unlikely to fly as it is complicated, would affect small businesses (which are often financed from house loans), smells of Muldoonism, and would be very hard to sell to the electorate.
I think it’s too hard right now to call what the Bank will do with the OCR next March. Much will depend on what happens to the New Zealand dollar over the next few weeks. The Kiwi remains high – driven by the relatively high interest rates here – and continues to hurt exporters.
A rise in the OCR will encourage a further inflow of funds into the country and keep our dollar up – the last thing exporters need.
Talking about flow of funds, there’s a few things happening out there that I believe will continue to hold up asset prices here – including property.
* The world continues to be awash with cheap money. We covered this in our September 2006 newsletter - see
nd it looks like it’s going to stay that way for a while. Much of the cheap money out of Japan, India and China ends up in countries that have the infrastructure and investment vehicle to handle the volume. See a Business Week article
For example, China’s trade surplus for 2006 hit a new record of US$177.5 billion – up 74% on 2005 – and it could hit US $200 million this year.
* The G7 conference this week failed to pressure the Bank of Japan into raising interest rates (their “cash” rate is currently 0.25%). Cheap Japanese money will continue to fuel Uridashi issues and the carry trade – see September 2006 newsletter referred to above.
* Taxation changes here for listed property vehicles. The new Portfolio Investment Entity regime will allow investors from 1 October to keep more dividends and pay less tax. Expect more money to be rushed into vehicles like Kiwi Income Property Trust and ING Property Trust – with new listings being formed.
* Private Equity has grown tremendously over the last few years. Most of the money being invested here comes out of Australia – driven by the compulsory superannuation there. Sure they’re looking at businesses mainly, but we’re starting to get the first whiff of interest in large property accumulation funds. Macquarie Bank in Australia has created the Macquarie Pastoral Fund. This is a wholesale fund marketing to institutions through which it plans to buy large cattle or sheep stations.
* Aussie super we’ve mentioned above. This is 9% of salary but next June every contributor to this very tax effective superannuation fund gets a one off chance to put up to $1 million into the fund (and up to $150,000 each year for the next 4 years after that). Nobody knows how much new money is involved – but it will be huge. And it all needs to be invested. New Zealand property must be a target for part of it.
* Australia’s biggest non-conforming residential lender is now offering commercial property lending there. This will be launched in New Zealand next month.
With all this money coming in, it’s difficult to see how property prices are going to come under downward pressure.
Even if the RBNZ raises interest rates in March there is so much competition from banks and new non-bank lenders - who have access to cheaper offshore money – it’s not a shortage of money that will be the issue for borrowers.
Lenders are becoming more conscious of the risk profile of proposals in a low yield market. There may be pressure to get the money out but there’s also pressure not to lose it. The structure and presentation of funding proposals is as important as ever.
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.