John Paine: July 2007 Finance Newsletter

John Paine: July 2007 Finance Newsletter

For the last few months, as I predicted, fixed interest mortgage rates have been rising. This is a result of the rise in interest rates offshore, which feed the fixed rates here.

Predicting what will happen next with offshore rates is not easy. This month the Australian Reserve Bank and the European Central Bank all held their official rates at 6.25% and 4.0% respectively, but the Bank of England raised its to 5.75%. All these were as was expected by the economic commentators – but who are also predicting further increases.

In the U.S. the Federal Reserve has raised benchmark overnight borrowing costs to 5.25% in 17 small steps dating back to June 2004, but has kept its base rate at 5.25% for some time now. With the sub-prime mortgage market not blowing out and a tight labour market - unemployment rate remains unchanged in June at 4.5% - current thinking is a rise is more likely than a drop.

An excellent view on the future of offshore interest rates is given by Rodney Dickens of Strategic Risk Analysis. He’s saying “With official interest rates in most overseas countries, including China, below the level needed to deal with the unfolding inflation threat, we see further iterative upside in international short-term interest rates before the current tightening cycle is over.” For information on this service use the following link http://www.sra.co.nz/interesting.html.

The New Zealand Reserve Bank is due to announce its Official Cash rate on 26th July. Here also a rise has not been discounted.

But what’s really interesting is the gap between floating mortgage rates – driven by the Official Cash Rate, and the fixed rates – driven by offshore rates, is narrowing.

On 30 June 2006 the bank average floating rate was 9.4%, while a year later it was 10.1%, a rise of 0.7%. However the average 2 year fixed rate rose 1.3% from 7.9% to 9.2%. Or looking at it another way, in 2006 the difference between the floating rate and the 2 year fixed rate was 1.5%, now it’s only 0.9%.

Looking back over the last 5 years there was a rapid rise in the fixed/floating gap from 2002 to 2003, a drop from 2003 to 2004, and then a massive rise from 2004 to 2006, before coming back in the last year. David Chaston of http://www.interest.co.nz/ prepared an excellent chart for me showing this. If you’d like a copy just send me an email with “send chart” in the subject line.

So the fixed rates are getting closer to the floating rate and the yield curve is much flatter. This means that borrowers can no longer avoid the pain of increased servicing costs by fixing their mortgage rates. As I said in last month’s newsletter, this is good news for Alan Bollard.

The bad news is of course high interest rates here, coupled with a continuing strong economy and full employment, will continue to keep the New Zealand dollar high and hurt exporters.

When National Party leader John Key, speaking at a Wellington breakfast in early April, said the dollar was likely to go as high as US 80 cents, many people laughed at the thought. Now nearly everyone’s saying it’s possible, especially as the USD is quite weak.

So what about this for an idea?

Let’s reduce the Official Cash Rate.

That’ll frighten the currency traders, Belgian dentists and Japanese housewives more than any intervention the Reserve Bank might make. To repeat the quote from the Economist in last month’s newsletter “Most nations with strong currencies should refrain from following [New Zealand’s] lead. After all, peashooters are of little use against a determined foe.”

For the reasons give above, and given the tools it has, it looks like the Reserve Bank’s objective of slowing the housing market has just about gone as far as it can go. No longer can house owners hide from increased mortgage rates by choosing fixed rates much lower than floating rates.

International ratings agency Moody’s this week published a report that says a slowdown in housing here is likely as owners fix at higher rates. And to see Bloomberg’s comments on the New Zealand currency and housing markets CTRL + click here http://www.bloomberg.com/apps/news?pid=20601081&sid=a0IOMI.RavPE&refer=australia#

So if the cash rate here was closer to Australia’s say, I would have thought that New Zealand’s higher risk premium would encourage investors, including the carry trade, to choose high yielding investments in alternative currencies. This would take the pressure off the NZ dollar.

And then maybe the country could get on with the real problem of businesses struggling under the weight of high overdraft rates and an overvalued currency.

Cheers

JP

John Paine B.Sc. Dip BIA Global Pacific Corporation Limited P O Box 3229,

Auckland, New Zealand

Email john.paine@globalpacific.co.nz Web site www.globalpacific.co.nz

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.

ENDS

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