The World Turns – Back To Floating

The turbulence of the past week will clearly cause a weakening of both economic growth around the world and inflationary pressures here in the short term. That means the Resrve Bank is highly unlikely to raise the cash rate in September and we must move back to predicting a December rise. That means borrowers can still enjoy record low floating rates without running a high risk of having fixed rates jump before they fix – if that is what they are planning to do. 99% + are not we think.

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BNZ Confidence Survey Shows Falling Optimism

Our monthly BNZ Confidence Survey has found a decrease in sentiment about where the economy will be in a year’s time to a four month low of a net 22% positive from 45% in July and a record 57% in June. Responses mainly came in after the large decline in world sharemarkets on Thursday night but the tone of comments regarding how people see things in their sector currently suggests the sentiment decline is a combination of offshore and domestically sourced worries.

In residential real estate buyers remain cautious but listings are in short supply, in construction conditions are very mixed, exporters are showing concerns about the high exchange rate, but interest rates barely rated a mention.


Monetary Policy Unchanged

The Reserve Bank met market expectations this week by leaving the cash rate unchanged at its record low of 2.5%. But they warned of rate rises ahead and we think risk averse borrowers might want to consider placing up to 50% of their debt at a fixed rate probably for three years. But huge uncertainty continues to swirl around the world economy and whatever one forecasts today is sure to change in coming months.

WO July 28


Risk Averse Borrowers May Want To Move

Recent strong economic data have led to bank fixed borrowing costs rising and this means fixed home loan rates are likely to be increased soon. For risk averse borrowers planning to fix their mortgage rates the time is at hand to bite the bullet and sacrifice the lowest floating mortgage rates in four decades in order to get protection against floating rates rising – probably from September.
July 26

Last week we learnt that New Zealand’s annual rate of inflation had risen to a 21 year high of 5.3% – or roughly 3.3% excluding the hike in GST last year. A week earlier we learnt that the economy grew 0.8% during the March quarter and not the 0.4% commonly estimated, and that the previously reported growth of 0.2% during the December quarter was revised up to 0.5%. Plus we have seen some strong readings recently in sentiment surveys, good levels of business hiring intentions, plus clear signs of a cyclical upturn getting underway in the residential real estate market accompanied by rising rents and slight increases in prices.

What these numbers show primarily is that the reason the Reserve Bank gave for cutting interest rates 0.5% after the February 22 earthquake, namely fears of a severe deterioration in the economy, no longer holds. What they also show is that with some fairly large stimulatory factors set to boost the economy over the next couple of years the time is at hand to at least remove the emergency 0.5% interest rates cut and to start taking away generally below average interest rates.

On the face of it these factors suggest that the Reserve Bank would raise its cash rate 0.5% at this week’s Thursday morning review of monetary policy. However we feel there are more than enough factors in play to encourage them to stay their hand for now, but start raising rates from September.

First there is the high level of the NZ dollar which is about 8% on average above the level they assumed for this time of the year. Second there are the continuing worries regarding sovereign debt situations in Europe and the United States. Third there is evidence of growth slowing in the Australian economy – our biggest trading partner – and some data suggesting consumers there may be more sensitive to interest rates now than in earlier years.

Fourth we have seen dairy prices fall about 20% since March. And on top of that some economic indicators have actually deteriorated recently including registrations for tractors, cars and commercial vehicles, and some sectors are in deepening recessions. These include viticulture, tourism, and house building.

But in spite of ourselves and the financial markets not expecting the official cash rate to rise until September, the interest rates at which we banks borrow funds to lend out at fixed interest rates have shot up recently. For instance what we call the one year swap rate has increased by 0.4% from a month ago, the three year swap rate has risen almost 0.4%, and the five year swap rate 0.25%.

These moves upward in funding costs have compressed bank margins on fixed rate loans and that means there is a very strong possibility that in the next few days or weeks those fixed home lending rates will go up. For borrowers this will make a slightly unusual situation even more confronting. At the moment most borrowers are paying floating mortgage rates and this is understandable as they are at four decade lows. Some are planning to fix in order to get protection against tightening monetary policy pushing those floating rates from current levels near 5.7% to 8% come the middle of 2013 and possibly up to 1% higher than that.

But fixing means adding the likes of 1.4% to one’s interest rate if one chooses a three year rate. For risk averse borrowers our forecasts imply the time is now at hand to make that leap with the floating rate likely to be above the current 6.99% three year fixed rate come the middle of next year. But we expect that only a very small number of borrowers will make that leap and this cycle is one during which most borrowers are likely to stay floating.

Be aware though that as happened in 1998 and again in 2008 there will likely come a time when fixed interest rates are below floating rates and some borrowers will switch to those fixed rates in order to improve cash flows. But they risk locking themselves into the likes of five year rates above current levels, forgetting the message that this relationship between floating and fixed rates tells us – namely that floating rates are set to fall. So if you are a borrower and plan to float just be aware of this fixing risk which at current best guess may come late-2013 or 2014. Personally speaking, if I were a borrower at the moment I would bite the bitter bullet and fix three years. 

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Real Estate Agents Report Rising Market Interest

Our monthly survey extracted responses from 742 licensed real estate agents showing a strong rise in interest in residential property from first home buyers, higher numbers of people through open homes, stronger auction clearance rates, and a perception now that prices are rising after three months of a belief that they were falling. The results bespeak of the start of a cyclical rise in the NZ housing market.
July Results
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BNZ Confidence Survey for July

Our monthly BNZ Confidence Survey has found a slight decrease in the net percent of Weekly Overview readers expecting the economy to improve over the coming year to a net 45% positive from 57% in early June. The result is still very high by the standards of the survey and suggests some good growth in the economy over the coming year. Results of interest in the survey include a noticeable improvement in sentiment in the legal sector, widespread shortages of residential real estate listings, and more balanced feedback from the retailing sector than the outright pessimism which has dominated for a long time.
Results July 11


Migration Loss To Australia Rises

The Kiwi dollar this week has risen back close to US 82 cents as worries about Greece have eased slightly and the March quarter current account deficit numbers came in slightly better than expected. We’ve also seen some buying against the Aussie dollar after the Reserve Bank of Australia made less hawkish noises about further increases in their 4.75% cash rate in the near future. Apart from that the week has not produced much in the way of fresh news about the NZ economy except for worsening net migration numbers as people head off to Australia.


What Businesses Want

Here is our analysis of the responses to our extra question in this month’s BNZ Confidence Survey regarding the one thing people would like to see the government do. Welfare reform and cutting spending come out well on top, but there is also strong support for training assistance, leaving KiwiSaver alone, tax reform, and stopping the exchange rate from rising. What Businesses Want


Are Farmers Spending Yet?

A traditional source of stimulus for the NZ economy is spending by farmers as their incomes rise on a commodity price boom. Based on discussions with farmers at National Farm Fieldays can we yet conclude that this spending boom is underway?

Farmers Spending on Catch-Up Capex.

 Last week for many of us was all about the National Farm Fieldays near Hamilton and in contrast with the last two years the underlying tone was definitely a positive one. The question I went in with and the one which investment bankers I met with in London wanted answered was when will NZ farmers start spending their largesse? The issue is a very important one because the traditional route toward faster economic growth in New Zealand is a jump in farm incomes which leads to higher capital spending and household consumption that initially boosts the regions and 12-18 months later hits Auckland. Some years down the track we notice it in Wellington.

Depending upon whatever else is going on it leads sometimes quickly to worries about resource availability and therefore inflation, and then rising interest rates bringing new upward pressure on a currency probably already rising because of strong commodity prices. What I found during three days at Fieldays is the following.

Farmers are catching up on delayed maintenance and undertaken capex which is strongly focussed on boosting productivity. There is spending on overseas travel but little indication of either a surge in spending on retail goods or plans to purchase “nice to have” items such as new large tractors with Ipod slots.

Farmers remain very strongly focussed on debt repayment but also many have an eye toward the long term and their perceived need to create a bigger farm through nearby land purchases. Some farmers are choosing to secure land currently available rather than buy equipment or build something new, while others with their farms on the market indicated they would remove them from sale if conditions remain strong.

Overall then the mix of spending being undertaken by farmers appears to be very good and at this stage there is little reason for believing that the Reserve Bank will be considering hastening their indicated timing for tightening monetary policy – though that is where the risk lies.

As regards the comments flowing the other way from myself to the farmers they were along these lines. The Kiwi dollar has strengthened over the past four months while the Reserve Bank has eased monetary policy. Interest rates are not yet having much impact on the Kiwi dollar (some for sure) and when they do start rising it is reasonable to expect that the Kiwi dollar will go higher against most if not all other currencies.

Farmers need to keep an eye on the labour market as we feel it has capacity to tighten up very rapidly next year and allowance should be made for higher wage and training costs. Farmers might also want to give thought to slowly increasing the proportion of their core debt at fixed interest rates – though without locking in 100% given the high cost currently when compared with floating.

Just briefly, following last week’s new earthquakes in Christchurch the damage needing to be repaired is clearly greater, but the time when reconstruction commences is also further out into 2012. At this stage we, like other forecasters, are simply assuming reconstruction starts in earnest from perhaps late this year. But we should all be prepared for further changes in forecasts for economic growth, interest rates and the exchange rate as we learn more about this timing. Oh, and events in Europe currently involving Greece also make the forecasting game even harder so treat all predictions of things economic as very very tentative.


Farmers Not Spending Up Large

This week we have seen the Kiwi dollar fall back to just over US 80 cents in response to a bout of heeby geebies gripping the markets following new riots in Greece and the failure of the Greek Prime Minister to form a coalition government. If the Greek situation worsens the NZD will fall further along with global sharemarkets. If progress is made on the bailout then fundamentals like good commodity prices and an expected tightening of NZ monetary policy come December will see the NZD going back up again.

Wholesale interest rates have eased slightly this week in response mainly to Monday’s earthquakes in Christchurch, with little impact from good consumer confidence readings and stronger than expected retailing numbers for the March quarter.

At Farm Fieldays there is strong evidence of farmers boosting capex, but little as yet to suggest a wider move of that spending surge into generalised retailing. Attention on debt repayment remains very strong for now.


Housing Market Stirring

New Zealand’s housing market has been in generally weak state since the middle of 2007 but we believe that partly driven by an improving labour market, awareness of shortages, plus low interest rates a cyclical upturn has started.

Housing Quietly Stirring To Life

New Zealand’s housing market is showing good signs of recovery in some areas with regard to sales, recovery in prices on a less widespread basis, and deepening recession if one speaks about construction. For turnover relevant to the real estate business we have just learnt that in May seasonally adjusted dwelling sales rose by 2.6% bringing growth for the past three months to 5.5%. This is a fairly strong rate of growth only a part of which is a bounce back after slight shrinkage of 1.9% in the three months to February.

But if we look at things regionally we see Auckland sales growth in the past three months of 12.7% following an 8% rise three months earlier, Central Otago 33% after an 8% fall, and Nelson/Marlborough 11% following a 9% fall. But in Southland sales growth was just 2% following a flat result earlier, Manawatu/Wanganui 4% growth after a 7% gain, and Waikato/Bay of Plenty. So experiences vary widely around the country.

The same goes for prices. On average around NZ prices have risen by 1.3% over the past three months. But they are ahead 4.1% in Auckland, and 1.2% in Christchurch (a tad surprising), and down 0.1% in Wellington. We don’t have data in hand for other regions. Prices are slowly creeping up with Auckland in the front.

Why the improving real estate activity? One reason is a strengthening labour market with job numbers ahead 30,000 in the March quarter and business employment intentions at well above average levels. Interest rates were also cut back to crisis levels by the Reserve Bank in the middle of March. Plus we think there is increasing awareness of a fundamental housing shortage in New Zealand – though this mainly applies to Auckland which experienced weak construction growth during the previous decade.

When it comes to house building however there is zero evidence of a nationwide recovery. In the three months to April the number of consents issued for the construction of new dwellings was down by a large 10.5% from the three months to January. Annual consent numbers now stand at 14,104 and look to be on their way to the four decade low of 13,600 recorded near the middle of 2009.

Why the construction weakness? We think it is a mixture of a lack of willingness to borrow money, low levels of speculative building, and absence of finance company funding.

So where are things likely to go? With regard to construction the answer is upward from late this year for three reasons. The first is that there is a very close lagged relationship between dwelling sales picking up and then three or so months later construction consents rising. Second is the rebuilding of Christchurch which we expect to begin in earnest early next year. Third, there is a period of catch-up construction due in Auckland following weak building during the previous housing market upturn which was driven by the regions.

With regard to turnover we see things continuing to improve, and for prices we see a few years of increases coming along. This is not simply because the cycle is turning that way. It is also a matter of the country having a housing shortage of some 41,000 at the moment which gets about 1,000 worse for every month when consents run near a 14,000 annual pace rather than the 25,000 needed to meet normal population growth.

In fact, although we see a building boom ahead, the ability of construction to reach levels such as 33,000 per annum experienced in mid-2004 will be severely constrained by the continuing lack of finance company lending and a shortage of builders. In addition fundamental demand for housing is growing as an aging population will tend to lead to a decrease in the average number of people per household. Plus there is the flood of demand to come form those who have stayed at home since the recession of 2008 soon acting on their improving job security by seeking their own home at last.

The upshot of a worsening demand versus supply situation will be an inevitable rise in prices which will be only mildly restrained by below average net migration inflows this year and next and rising interest rates from probably December this year.

Monetary Policy Unchanged

 Our view on NZ growth remains firmly positive, but for now one still struggles to find data outside of booming merchandise export receipts to show strong growth. In particular short term construction prospects remain weak and businesses are cutting back investment except on commercial vehicles. Still, with our monthly survey showing confidence in the economy a year from now at a record high we feel on reasonably safe growth with our warnings regarding tightening labour availability, rising inflationary pressures, tightening monetary policy from late in the year, and eventually firmly improving housing market activity.


Kiwi Dollar Hits A Post-Float High

The main event of interest with regard to the NZ economy this week was a rise in the NZD above 50 pence and to a post-float record against the greenback in response to a variety of factors. There was initially last week’s news about $6bn of Chinese investment in NZ, then a very strong report on export growth in April, further commodity price gains reported in May, and soaring business confidence as we reported over three weeks ago in our monthly survey.