Today, the Reserve Bank kept the official cash rate unchanged at 1.75%.

Reserve Bank of New Zealand OCR Statement

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 1.75 percent.

The outlook for global growth continues to gradually improve. While global inflation remains subdued, there are some signs of emerging pressures. Commodity prices have continued to increase and agricultural prices are picking up. Equity markets have been strong, although volatility has increased. Monetary policy remains easy in the advanced economies but is gradually becoming less stimulatory.

GDP was weaker than expected in the fourth quarter, mainly due to weather effects on agricultural production. Growth is expected to strengthen, supported by accommodative monetary policy, a high terms of trade, government spending and population growth. Labour market conditions are projected to tighten further.

Residential construction continues to be hindered by capacity constraints. The Kiwibuild programme is expected to contribute to residential investment growth from 2019. House price inflation remains moderate with restrained credit growth and weak house sales.

CPI inflation is expected to weaken further in the near term due to softness in food and energy prices and adjustments to government charges. Tradables inflation is projected to remain subdued through the forecast period. Non-tradables inflation is moderate but is expected to increase in line with a rise in capacity pressure. Over the medium term, CPI inflation is forecast to trend upwards towards the midpoint of the target range. Longer-term inflation expectations are well anchored at 2 percent.

Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.

 

Our Take:

GDP and Inflation

As expected, the Reserve Bank held interest rates at a record low and indicated it does not expect to raise them anytime.  That is, as long as economic growth loses momentum and inflation remains subdued. The soft landing of NZ Gross domestic product was confirmed last Thursday, March 15, 2018, when it only increased 0.6 percent in the fourth quarter, just missing the RBNZ’s projection of 0.7 percent. Adding salt to the weaker than expected GDP wound, economists predict growth in the first half will fall short of the central bank’s forecasts as business confidence remains weak. Slower growth adds to risks that inflation won’t pick up as quickly as the central bank expects. In its February projections, the RBNZ predicted inflation would lift to 1.8 percent by the end of 2018 — near the midpoint of its 1-3 percent target range.

NZ vs US

Likewise, we have to bear in mind that New Zealand’s benchmark rate has been at a historic low since November 2016 as exchange-rate strength and weak global inflation exert downward pressure on prices. Even as the Federal Reserve raises interest rates and says it is wary of emerging price pressure in the U.S., few economists expect an RBNZ rate increase before 2019.  An expectation is contrary to the central bank previous monetary policy that signalled in February that rates would be unchanged until mid-2019, and since then economic growth has not revived as much as it expected.

No wonder why the New Zealand dollar was little changed after the statement. According to Bloomberg, all 16 economists surveyed by Bloomberg expected today’s decision, and most forecast the OCR will remain at 1.75 percent until next year. In addition, traders have reduced bets on a rate rise this year, pricing just a 31 percent chance of a move, according to swaps data compiled by Bloomberg today. Also worthy of note, the central bank governor Spencer omitted any comment on the exchange rate in today’s statement.

A change of leadership

Spencer, who has been in a caretaker role the past six months, steps down next week. New governor Adrian Orr will be charged with implementing the biggest reforms at the central bank in almost three decades as the government introduces a Fed-style dual mandate of full employment and price stability. It also proposes adding external members to the RBNZ’s policy committee.

While New Zealand’s economy has been expanding at a healthy clip the past several years, supported by immigration and booming tourism and construction, growth has stuttered as capacity constraints curb building activity. Business confidence is only slowly recovering from the eight-year low hit in November as firms remain uncertain about how the new government’s policies will affect them. Still, consumer confidence has rallied and the housing market has also stabilized after a rapid cooling in 2017. Annual house-price growth was 6.5 percent in February, Quotable Value New Zealand said this month. As the US Federal Reserve indicated that there will be at least two and probably three more +25 bps hikes in 2018, most likely RBNZ will be tempted to join the bandwagon as started by the US Federal Reserve. The US benchmark could be 2.50% by the end of the year while RBNZ OCR is still at 1.75%.

Today, the Reserve Bank kept the official cash rate unchanged at 1.75%.  It also continued to signal rates won’t lift until mid-2019 at the earliest due to the lack of inflationary pressure.

Here are our notes from today’s announcement:

House Price Inflation

The Reserve Bank has noted a rise in house price inflation, while it has also revised down the economic impact of the new Government’s measures. It says that annual house price inflation is forecast to stabilise at around 2% in the medium term. The observed increase in monthly house price inflation over the second half of 2017 “is assumed to be short-lived”.

The Reserve Bank says that given low interest rates and excess demand for housing, house prices could rise by more than it assumed. It says the KiwiBuild housing programme is expected to generate faster growth in residential investment from 2019.

Annual Consumption

The Reserve Bank says annual consumption growth slowed to 3.4% in the September 2017 quarter. An increase in government transfers and allowances is expected to raise household incomes and contribute to consumption growth over the projection. Consumption is also expected to be supported by low interest rates, elevated terms of trade, and population growth. Low house price inflation is expected to have some dampening effect on consumption over the medium term.

GDP

The Reserve Bank has trimmed back short-term forecasts for GDP growth to 1% from 1.2%.  It does also see stronger GDP growth later in this year and into next year. It now forecasts 1% growth in the March 2019 quarter versus an earlier forecast to 0.7% made in its last Monetary Policy Statement in November.

In terms of inflation, the Reserve Bank has responded to weaker than expected recent figures.  It’s done this by trimming where it sees annual inflation ending this year at. Earlier, it saw annual inflation of 2.1% by the end of this year, but now it iss forecasting 1.8%.

Summary

 

It appears that the OCR chart above is eventually heading to the upside.  The Reserve Bank today kept the rate unchanged at 1.75% and has done since January 2017. The possible catalyst for this move could be the domino effect of the overseas interest rates hikes – particularly the US – despite the local lack of inflationary pressure.

What is the OCR?

The OCR is an interest rate set by the Reserve Bank of New Zealand which defines the wholesale price of borrowed money. This directly affects the commercial banks, determining the rates they offer their customers. So it affects the rates banks charge for borrowing (mortgages, loans, credit cards) and what they will pay customers for saving (term deposits, savings accounts). The Reserve Bank reviews the OCR eight times a year.   Monetary Policy Statements are issued with the OCR on four of those occasions. Unscheduled adjustments to the OCR may occur at other times in response to unexpected or sudden developments, but to date this has occurred only once, following the 11 September 2001 attacks on the World Trade Centre in New York.

What the OCR does

The OCR influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. An OCR is a fairly conventional tool by international standards. In the past, the Reserve Bank used a variety of tools to influence inflation, including influencing the supply of money and signalling desired monetary conditions to the financial markets. Such mechanisms were more indirect, more difficult to understand, and less conventional.

How the OCR works

Most registered banks hold settlement accounts at the Reserve Bank, which are used to settle obligations with each other at the end of the day. For example, if you write out a cheque or make an EFTPOS payment, the money is paid by your bank to the bank of the recipient. Many hundreds of thousands of such transactions are made every day. The Bank pays interest on settlement account balances, and charges interest on overnight borrowing, at rates related to the OCR. These rates are reviewed from time to time, as is the OCR. The most crucial part of the system is the fact that the Reserve Bank sets no limit on the amount of cash it will borrow or lend at rates related to the OCR.

 

The graph shows that the path of 90–day bank bill rates closely follows the OCR.

As a result, market interest rates are generally held around the Reserve Bank’s OCR level. The practical result, over time, is that when market interest rates increase, people are inclined to spend less on goods and services. This is because their savings get a higher rate of interest and there is an incentive to save; and conversely, people with mortgages and other loans may experience higher interest payments.

When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce. Although the OCR influences New Zealand’s market interest rates, it is not the only factor doing so. Market interest rates – particularly for longer terms – are also affected by the interest rates prevailing offshore. New Zealand financial institutions are often net borrowers in overseas financial markets. Movements in overseas rates can lead to changes in interest rates even if the OCR has not changed. (source: taken from RBNZ website)

How does the OCR actually affect interest rates?

The OCR was introduced in March 1999 and is reviewed seven times a year by the Reserve Bank. The OCR is actually the interest rate for overnight transactions between banks. Among other things, the Reserve Bank acts as the central bank for most registered banks in New Zealand, who hold settlement accounts at the Reserve Bank.

To explain, if you write out a cheque or make an EFT-POS payment, the money is taken from your bank and put into the bank of the recipient. This causes the money within your bank and every other bank to go up and down each day according to what their customers are spending or depositing.  Depending on daily transactions, individual banks can end the day in credit or debit.

Much like an overdraft account, the Reserve Bank covers the ups and downs by either paying or charging interest to banks depending on whether they are in credit or debit. Banks can borrow money from the Reserve Bank at a rate 0.25 percent higher than the OCR, or lend money to it at a rate 0.25 percent lower than the OCR.

Short term interest rates are therefore influenced by the OCR because banks are unlikely to lend money to people for rates less than they could receive from the Reserve Bank, or to borrow at rates higher than they would pay the Reserve Bank.

By affecting overnight rates, the Reserve Bank has a strong influence on short-term interest rates such as the 90 day bill rate and floating mortgage rates.

However the impact isn’t direct and may not be immediate. While overnight interest rates will respond quickly, longer-term interest rates may not. Some overseas investors will respond quickly to changing interest rates, but most consumers and businesses won’t.  Why does the Reserve Bank change interest rate?

As the OCR affects short term interest rates, if a majority of mortgages are on long term fixed rates, then the OCR will have little effect on mortgage rates. (Source: New Zealand Property Investors’ Federation website)

Why does the Reserve Bank change interest rate?

The Reserve Bank is responsible for implementing monetary policy in New Zealand. It operates under the Reserve Bank of NZ Act 1989 which states that the Bank must maintain price stability. The Bank also operates under the Policy Targets Agreement (PTA) that it signs with Government.

The current PTA, signed in September 2012, defines price stability as annual increases in the Consumers’ Price Index (CPI) of between 1 and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 percent target midpoint. The CPI is a list of 690 goods and services, whose prices are monitored by Statistics NZ to see if they are going up or down.

The Reserve Bank monitors the NZ economy and uses this huge bank of data to make predictions on where it sees the CPI and hence inflation is tracking. If the Reserve Bank believes that inflation is going to go beyond the range it has been instructed to keep within, it will use the OCR in an attempt to keep inflation within the range.

As interest rates rise, people spend less, either because there is an increased incentive to save rather than spend or people with mortgages and other loans have less to spend. When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce.

In addition to having an influence on interest rates, unfortunately the OCR has an effect on other economic factors. As interest rates increase, NZ becomes more attractive to overseas depositors, who buy NZ dollars to access the higher interest rates. This increased demand for the NZ dollar increases its value compared to other currencies which makes NZ products more expensive in overseas markets.

One reason the Reserve Bank introduced restrictions on Loan to Value Ratios (LVR) was to influence inflation. The theory is that if people are required to have higher deposits when buying property, this will encourage them to save more to get a higher deposit. This reduces spending as well as the risk of over borrowing, while not having an effect on the exchange rate.

As with anything the Reserve Bank does there will be winners and losers as a result of these restrictions. This then begs the question, have we got our inflation targets set correctly in the first place?

Mainstream banks have started to respond to the LVR (Loan to Value Ratio) restrictions following the Reserve Bank’s announcement on November 29th 2017.

LVR on Investment properties

Most major banks have indicated that, as of 1st January 2018, they will begin lending up to 65% on investment properties (up from 60% this year).

Example:

Let’s say a couple have their own house and want to buy an investment property, both valued at $500,000.  Previously they could borrow up to 80% on their own home ($400,000) and 60% on the new investment property ($300,000).  In other words, the total borrowing on their $1 million property portfolio would be $700,000.

As of the 1st January 2018, the same couple will be able to borrow $400,000 on their own home as before.  But now they will be able to borrow $325,000 (65% LVR) for a total borrowing of $725,000.

Is this enough?

With the new rules, it is slightly easier to borrow to purchase an investment property.  It won’t open the flood gates but buyers who are currently just short of being able to buy may find themselves back in the market.  I think this is exactly the outcome that the Reserve Bank are hoping for.

Low (high LVR) Deposit Buyers

There has been some confusion around this change of policy.  Currently, 10% of any bank’s new owner-occupied mortgages can be lent to clients with less than 20% deposit.  In other words, those with higher than 80% LVR.

The LVR mark is still 80% however the banks can now lend up to 15% of their new owner-occupied mortgages to low deposit buyers.

And banks are already indicating how this is going to change.  One bank, who has recently declined almost all mortgages over 85%, has indicated that they are now more prepared to look at up to 90% again.

Is this enough?

A mere 5% increase in available lending doesn’t sound like much.  But the question has to be asked, what percentage of lending goes to low deposit buyers if there are no restrictions?  Of course, it’s not 100%.  A large portion of mortgages will always to be low LVR owners simply due to the nature of capital growth.

Given this, I think the change to the available lending is going to more significant than it initially sounds.  And the great news is, this is going to affect first home buyers the most (for the better).  This will allow those with a deposit hurdle more of a chance to get into the home they want.

Summary

Some exciting changes are happening to the property market.  The 2 main changes are:

• Investment property buyers no longer require as much deposit to purchase
• Low deposit borrowers have a better chance of being able to get a mortgage if they are borrowing >80%