Peak pessimism passed.
Back on October 18 when the annual inflation rate came out for New Zealand the number was a lot worse than expectations. At 7.2% the annual increase in the cost of living was well above market expectations for a 6.6% result. Expectations of tightening monetary policy led to a 0.5% round of increases in most fixed mortgage rates.
On November 23 the Reserve Bank gave their response to the higher than expected inflation rate by raising the official cash rate a record 0.75%, lifting their pick for where the cash rate would peak from 4.1% to 5.5%, and warning that the economy was probably headed into recession.
As a result of their scary words, we have seen a sharp decline in measures of both business and consumer confidence along with sharply reduced intentions to hire people, undertake capital expenditure, and spend household money on essentially everything.
People grow fearful
We have also seen a new pulling back of buyers from the residential real estate market as people grow fearful not just of the projected increase in interest rates but property prices falling even further.
There is a good chance that we may just have passed the peak level of pessimism in the home buying sector as a result of a couple of developments. The first development is a downward trend in bank funding costs for fixed rate lending driven by weak economic indicators in the United States and falling inflation there. These numbers have led to falls in expectations for the extent to which monetary policy will be further tightened in the United States and that has fed through to borrowing costs here as well.
These falls in bank funding costs have been sufficient for one bank recently to cut their fixed mortgage rates for periods of three years and beyond while also increasing their one and two year fixed rates. The higher one year rate looks to have been justified on the basis of some small increase in the cost of funds, but the increase in the two year rate appears opportunistic and aimed mainly at boosting already above average fixed rate lending margins.
All up, the importance of the latest inflation number is that it was not a repeat of the shock three months earlier. That has allowed analysts to focus back in on underlying trends and economic data in New Zealand including the inevitability of falling inflation in response to the sharp decrease in leading economic indicators such as confidence measures.
It’s going to take quite some time for potential home buyers and people rolling off existing fixed rate mortgages to stop focusing on worst case scenarios involving another 1% going on fixed mortgage rates. For floating mortgage rates another 1% increase is highly likely because the cost to a Bank of borrowing money to lend floating is closely tied to the Reserve Banks official cash rate.
Another cash rate rise
A rise in the official cash rate will push floating mortgage rates higher. But fixed mortgage rates depend upon the cost to a Bank of borrowing to lend fixed and those fixed borrowing costs are based on expectations for where the official cash rate will go over the relevant one, two etc time period. Because the markets have already factored in the cash rate going to 5.5% fixed borrowing costs have already adjusted.
Possibly before we get to the official cash rate review on April 6 people’s general attitudes and fears about where mortgage rates are going will have changed. That change might even come on February 22 when the Reserve Bank undertakes its next review of the cash rate.
What does this mean from a borrower’s point of view? As yet we cannot be confident in anyone’s forecasts for when monetary policy actually starts easing in New Zealand, the speed with which it will be eased, and the level to which interest rates will eventually fall to. There is simply much too much water to go under the bridge with regard to inflation, international oil prices, shipping costs, food prices, supply chain functioning, etc. for us to have any confidence beyond the next few months in where inflation is headed.
But optimism about interest rates falling will eventually grow and at some point, perhaps in the next two months this will start to bring some extra buyers back into the housing market. Then again, there is a tendency for most areas of economic activity to pull back slightly in an election year and there is little reason for believing that would not be the case this year as well.
House prices on average will fall further
It still seems reasonable to expect that house prices on average will fall further over the next few months and perhaps bottom out broadly towards the middle of the year. At some stage buyers are going to return in greater numbers, but ahead of the general election the extent of that improvement is likely to be relatively minor.
This means first time buyers probably still have a good amount of time on their side before they find themselves competing again with investors. But those young buyers should note that the opposition National Party have promised to restore the deductibility of interest rate expenses and take the brightline test down from 10 years to two years.
These changes will bring more investors back into the market but as noted above probably not to a great degree ahead of the general election.
Things remain in a considerable state of flux in the residential real estate and interest rate markets in New Zealand. But it is looking increasingly likely that the peak period of pessimism with regard to where borrowing costs are going has just passed.