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Sludge Report #174: RBNZ Remains Housing Fixated

Sludge Report #174: RBNZ Remains Housing Fixated

Includes full audio of today's RBNZ Governor's press conference
Official Cash Rate Hiked by 25 Basis Points
By C.D. Sludge
Also posted to Scoop's Eco-Economy email list

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From today's Monetary Policy Statement it appears that our Reserve Bank Governor Dr Alan Bollard remains fixated on New Zealand house price inflation. Unfortunately on the face of things there doesn't seem to be much he can do about it.

"A return to a moderating trend in housing and domestic demand " is what he today says he wants – if we are to avoid " medium term inflationary pressures ", by which he means further interest rate rises.

However from this MPS it is also apparent that there is growing recognition inside the bank that there is not a lot it can do about its biggest bugbear.

In theory by raising its official interest rate the bank is supposed to be able to increase mortgage rates, thereby reducing household incomes, and - theoretically - reducing our willingness to spendup big on housing and household expenditure.

And so today as expected (by 15 out of 16 economists according to Reuters) the bank raised the Official Cash Rate by a quarter of a percent.

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But in practical terms this is unlikely to mean a great deal, if anything.

Firstly the financial markets – including bank mortgage rates - have already priced in this entire increase.

Effectively what this means is that had the Reserve Bank not raised the official interest rate today there may have been a fall in mortgage interest rates in the next few weeks.

As it is - given today's 25 basis point rise - mortgage interest rates seem likely to stay roughly where they are.

It is of course up to the retail banks what precisely happens. But as a competitive desire to lend Kiwi battlers as much mortgage finance as they are collectively able to scrape together seems to have become the NZ banking community's guiding principle, the prospect of meaningfyl across the board interest rate rises in coming days seems fairly remote.

And inside the MPS one quickly discovers the source of Dr Bollard's frustration.

Fig 4.9: Graph showing the diminishing effect of OCR rises on effective mortgage rates

In the past few years New Zealanders have deserted the previously fairly common floating interest rate mortgage (which was for several years a cost effective method of borrowing). This form of mortgage is realistically speaking the only thing that the Reserve Bank's announcement today is likely to effect – aside from the exchange rate which it is likely to encourage back on an upwards path.

Fig 4.8: Graph showing the average time till the expiry of fixed mortgages

The effect of the move to fixed interest rates that has resulted from this clear market signal is compounding. The first effect is a lag in the time taken for any OCR effect to have a meaningful effect on household incomes. The above graph shows that the mortgage market is less responsive now to OCR changes than it has ever been. Dead reckoning tells is that roughly half the fixed rate mortgage holders will not be effected by today's rise for at least 2 years.

And the switch to fixed rate mortgages is hardly surprising given the clear market signals given by mortgage pricing.

If you are one of the minority of householders to have the misfortune to still have a floating mortgage you are probably paying a little over 1.5% more than the 5 year fixed rate today. By next week it is possible you may be paying up to 1.75% more than your neighbours. (Assuming a 1.6% margin on a $200k mortgage that is $3200 a year or $64 a week.)

From the MPS (page 20) you can see that the divergence in floating and fixed rates began in mid 2004.

Fig 4.7: Graph showing the relative effect of OCR rises on fixed and floating mortgages

Since mid 2004 the Reserve Bank's OCR (& floating rate) has risen by 150 basis points (1.5%). But over the same period the 5 year fixed rate has actually declined a smidgen, and the 2 year fixed rate has climbed by less than half a percentage point.

The Reserve Bank tries hard to put a positive spin on this by pointing out in the text that the "effective mortgage rate" has risen by 110 basis points since its lows in 2003 (see fig 4.9 above).

However nearly all the burden of this rise has been experienced by the relatively small number of people with floating interest rate mortgages. None has been experienced by those with 5 year fixed mortgages.

Moreover by dead reckoning from the graphs it appears that nearly three quarters of this modest increase in mortgage costs over the past four years took place in the first 12 months up to mid 2004.

All of which points to the futility of the Reserve Bank's attempts to control house price inflation through the OCR.

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And so it is not surprising that the bank acknowledges this invidious position in its statement today when it says:

"We are continuing to assess alternative measures that might support the OCR, working with the relevant government agencies. These include a tightening of tax rules applying to housing investment and changes to bank capital requirements to help moderate the amplifying effect of credit on the housing cycle."

Wishful thinking some will say – especially if the bank is holding out for capital gains taxes on residential housing investment. [During the Q&A Dr Bollard made it clear this is not what he means – rather he is hoping that a change in IRD policy is going make speculation slightly less tax effective at the margins.]

With regards to the second leg of its plan to tame retail bank profligate lending – changing capital requirements on banks – Dr Bollard is less than clear at this stage and it would appear ( from the Q&A) that this is going to initially take the form of a stern talking to.

The bank continues in its statement:

"However , we will continue to rely on the OCR as the primary instrument of monetary policy."

Meaning: They really know there is nothing they actually do about all this.

And so out of today's expected announcement the clearest result we are likely to see is increased discussion of alternative methods of taming New Zealand's love affair with property speculation.

There is no obvious track for this discussion to take however as the briefly pondered "mortgage levy" is now a dead duck, and a "capital gains tax" has become politically speaking "the-tax-that-must-not-be-named".

Many of these questions raised in the above analysis were pursued during the question and answer session that followed today's media lockup, and which continued for an unusually long 30 minutes.



Some Questions and Answers

Scoop Audio.Listen to the Reserve Bank Governor's Press Conference (29 Minutes)

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