We have shifted our forecast to no change in the OCR in September and October. Nearly all economists are now picking a pause next week, and interest rate markets are pricing only a one in four chance of a hike. But where our view differs – certainly from market pricing at least – is that we expect the September Monetary Policy Statement to continue to push the message that the OCR will need to move higher as the economy recovers.
Note: this report was prepared before the 7.1 magnitude earthquake that struck the Canterbury region over the weekend. Please see our Bulletin “Shaky isles” for our assessment of the economic impact of this event.
As the RBNZ noted in its July statement, the tone of the recent data warrants a more moderate pace and extent of tightening than was projected in June. By our estimates, that could see the OCR peaking in mid-2012 around the 5.00- 5.25% range, compared to a 5.75-6.00% range previously. But from a starting point of 3.00%, that still doesn’t leave a lot of room for the RBNZ to drag its feet.
As a result, this represents a change to the expected timing of hikes, not a downgrade to our overall interest rate projections. We had already acknowledged that a pause in the tightening cycle was likely at some point in the next few months – previously we had it pencilled in for December. But with the RBNZ facing a highly uncertain global environment, mixed signals on the domestic economy, and now the biggest financial sector failure in nearly two ecades, bringing the pause forward to September is a low-risk option.
The failure of South Canterbury Finance, the largest non-bank-owned finance company (though still only accounting for around 0.5% of financial system assets), goes further towards making a pause the more tactful option for the RBNZ. however, in our view the net economic impact is likely to be close to zero. Bear in mind that the new development here is SCF’s receivership (and the government’s payout to depositors); any consequences should be weighed against the alternative of the firm continuing to limp on as before.
Under the Retail Deposit Guarantee, around $1.6bn will be paid out to depositors in coming weeks. A large share of term deposits are held by retirees who rely on the regular interest income. So rather than being treated as a ‘windfall’ to be spent, we expect the vast majority of these funds will go towards similar investments – deposits at banks and building societies, and bonds from the higher-rated corporate issuers. It’s possible that these funds could be recycled into new lending, thereby stimulating the economy. The key is whetherthe main constraint on credit growth is supply or demand; the evidence seems weighted towards the latter.
Finally, access to finance is likely to be a sector-specific issue. While SCF has been portrayed as a major player in rural
lending, this made up only 18% of its loan book as at the end of 2009 – about the same share as the major retail banks. Its greater exposure was to property development, a sector that is already under pressure to evolve towards new methods of financing.
On the data front, the news was mixed last week. Residential building consents rose 3.1% in July, but that was driven by a rise in the lumpy apartments component. Single-home consents fell by 5.3%, and are now below end-2009 levels. Tax changes, slower population growth and higher mortgage rates continue to have a cooling effect on the housing market compared to a year ago. READ MORE >>
Fixed vs. floating
The gap between fixed and floating rates has narrowed significantly – partly because financial markets are questioning the RBNZ’s resolve to return the OCR to normal levels. Borrowers who believe that the economy is simply wobbling along the path to recovery, and therefore that the RBNZ will continue to normalise the OCR in the next few years, will find today’s 2-3 year fixed rates very attractive. Those who believe that markets are presaging a return to recession will be more attracted to floating rates.
View the Key Data Previews PDF here >>
Previous Westpac Weekly Commentary
Westpac Weekly Commentary 06 September 2010 >>
Westpac Weekly Commentary 16 August 2010 >>
Westpac Weekly Commentary 09 August 2010 >>
Westpac Weekly Commentary 02 August 2010 >>
