The World Remains A Challenging Place - Fresh economic data releases have been thin on the ground in New Zealand this week, but offshore it has been a different story., but offshore it has been a different story. In Europe we have seen a lift in German business confidence to a  three year high coming hard on the heels of an earlier report showing 2.2% growth in the German economy during the June quarter.

But while this augurs well for the Euro area’s short term economic prospects there are rapidly growing  concerns about the ability of high budget deficit countries to continue their fiscal austerity programmes as their  economies shrink and unemployment heads skyward.

Article Quick Links:

• Tony Alexander Comments
• If I Were a Borrower What Would I Do?
• If I Were a Term Deposit Investor What Would I Do?
• Previous Economic Comments

Tony Alexander Comments
This growing concern about Europe’s finances has led to a fresh blow-out in the premium which indebted governments  must pay to raise debt from investors. In Greece the cost of borrowing measured as a margin above German bond  yields has risen back to over 9% and sits just 0.5% below the peak margin reached during the depths of the fiscal crisis  early this year. Standard and Poors have cut the credit rating of Ireland, and commentary is becoming more and more  conspicuous regarding probable default/debt restructuring. 

In other words, the glass half full interpretation being given to  he European debt situation is in the process of evaporating and changing back to glass half empty.

In the United States  talk is less about government debt problems (that issue lies further down the track there) and more about the economy’s inability to sustain the recovery which so far has been driven by a low greenback boosting exports plus special fiscal and  onetary stimulus measures. Two weeks ago the Federal Reserve reacted to the reducing prospects of growth  continuing by loosening its quantitative monetary policy a tad more. This week data have appeared showing that the  ending of a special tax credit for house purchases has produced a plunge in house sales at the same time as indicators  for the manufacturing sector and labour market have turned out to be weaker than expected.

For New Zealand the  relevance of this growing concern about global growth is reductions in long term borrowing costs which have led to cuts  in bank fixed housing interest rates with probably more to come in the near future. Prospects for the pace of NZ  monetary policy tightening have also changed with the RBNZ now more and more likely to take a decent pause after only  two cash rate increases.

The Kiwi dollar has weakened below the US 70 cent level as investors have pulled their  funds away from volatile risky assets like our far flung currency. This move lower will be welcomed by exporters but they should remember that because the driving force in the currency’s decline is world growth worries thedownside will be reduced demand for exports all up.

With regard to food exports however the picture is a tad more mixed because of rising global concern about food  availability and cost following the drought in Russia and floods elsewhere cutting grain production. This probably  explains why after announcing they would announce a review of the milk solids payout Fonterra made the announcement  last week of no change!

Of course these sort of things are the obvious economic ones we have seen before and there  are natural equilibrating movements in interest rates and exchange rates which help insulate our economy from the turbulence offshore. But a key factor we need to keep an eye on is the one which would have sent us into a Depression  scenario in 2008-09 if things had not eased up and which was becoming a concern again a few months ago when  worries about Europe were at their peak – ability of NZ banks to raise funds offshore.

We banks have to raise about  40% of the funds we lend out in New Zealand from investors offshore. As worries about Europe and the world economy  grow again the cost of raising these funds will go up – thus offsetting some of the falls in wholesale funding costs which  have allowed fixed interest rates to decline. In addition our ability to raise long term funds will once again become  compromised. 

None of this yet adds up to anything approaching the late-2008 situation and we remain of the firm  opinion that the economies of our trading partners and our own economy will continue to grow at acceptable paces on  average next year. But two years down the track from the collapse of the Lehman Brothers investment bank the world  remains a still very uncertain place with a few bad things like European debt default still quite likely to happen.

That  means both householders and businesses are probably doing the exactly the right thing at the moment. Showing above  average confidence regarding the economy in the coming year (evident in practically every survey available) but  nonetheless guarding their cash tightly and focussing more on getting debt down than gearing up for a bright economic  future which frankly may not appear until this current impossible to predict cycle has run its course and we get set for the next one further down the track.

If I Were a Borrower What Would I Do?
Things have changed enough here and overseas that we feel the Reserve Bank will now not raise the official cash rate  again until December. That means steady floating rates until then and little reason for jumping into a fixed rate unless one  xpects the fixed rates to suddenly rise. So if you are a conservative person you might put some of your mortgage at  a two year rate simply for safety as we noted last week. But practically everyone will probably be best served by staying  on the floating rate many have been on since the middle of last year and waiting until we get some greater clarity about  where things are going. Note that given the way swap rates have decreased yet again this week we could see some  further falls in bank fixed interest rates.

With regard to the graph below, what it shows is the following. The blue bars are what we think the floating rate will  average over the coming year. For the next year that is 6.9% which compares with the current one year floating rate of  6.7%. It is cheaper to fix than float. The forecast floating rate for the next two years is 7.7% versus the two year fixed rate  currently at 6.7%. A person will save about 1% fixing rather than floating. The forecast floating rate for the next three  years is 8% which compares with a three year fixed rate of 7.15%. it is again cheaper to fix than float.

But as noted above, borrowers probably still have time on their side to float before jumping into fixed. Late last year we  picked the point for sacrificing low floating to secure a low fixed rate before it jumped up to be in the period from May  into July. Now it looks like that period will come much later this year. Floating therefore remains optimal for all but the  most conservative. But be aware of one important thing.  View all graphs here >>

If I Were a Term Deposit Investor What Would I Do?
Nothing new. I would have most short term but some toward five years to improve the average yield.

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Previous BNZ Weekly Overviews
BNZ Weekly Overview 19 August 2010  >>
BNZ Weekly Overview 06 August 2010  >>
BNZ Weekly Overview 01 August 2010  >>
BNZ Weekly Overview 26 July 2010 >>