OCR Stays At 1%: Be Careful What You Wish For

Be careful what you wish for, lest it come true!

In The Old Man and Death, one of Aesop’s fables, an old man is so tired of his life gathering wood that he asks Death to take him.

But when Death shows up, the man changes his mind. He asks if Death will put the wood back on his shoulders and let him live.

A bit late…

Well, I feel like that old man after the Reserve Bank announcement this week.

Like the other analysts, I presumed (and hoped) that the OCR would get left at 1%. Allowing the Kiwi dollar to strengthen. Allowing our investors to buy forex and shares with some hope of value.

We got what we wished for. But now look at the implications…

We are 25 basis points ahead of Australia’s interest rate

The Reserve Bank of Australia’s cash rate sits at 0.75%. This low rate has helped the Australian economy battle bush fires, the stagnant housing market, and the Chinese slowdown.

New Zealand’s economic cycle often lags behind Australia.

Any malaise that Australia is facing could be far worse on our small, open economy.

Reserve Bank Governor Adrian Orr noted that coronavirus is an emerging downside risk. But he also said that, with planned government spending and indications of improved household spending, monetary policy had a long enough gangplank to adjust.

The trouble is that the investments needed to combat a potential slowdown may take 12 months or so to come on stream. And there’s no guarantee that the coronavirus will be over with this quarter.

A lower cash rate now could have equipped the economy with some tougher tyres for the rough road ahead.

We’re still highly indebted at a household level

The Reserve Bank must surely have an eye on hazardous debt levels. Drop the OCR and you risk a bonfire, especially in the Auckland housing market, as people take on more and more debt to climb the moving ladder.

But there are also signs that housing supply is increasing. Migration is slowing. New Zealand sits at high-risk due to its export reliance on coronavirus China.

If the risk premium that global investors place on New Zealand increases, asset values could start to fall.

Lower interest rates and a softer currency would have provided more insulation.

This is insulation for those already in debt, facing significant interest costs.

Other levers such as setting LTV (loan-to-value) requirements, alongside low interest rates, could be an alternative to stem the housing addiction.

The housing crisis is an atomic bomb waiting to explode

A friend of my wife’s — who lives in Auckland — unwillingly purchased a Wellington rental property the other weekend.

Reason: her daughter is studying there and had become distressed trying to find a rental. (200 people turned up for the last viewing).

Anecdotally, landlords seem to be a declining breed. Increased regulation, alongside tougher tax implications, seems to be putting them off.

They need lower interest rates just to get by.

But, in reality, the government needs to step in and remove the housing fiasco from the equation. The market is failing in many areas.

Let the State build a rental portfolio on government wholesale borrowing rates. Then float the enterprise in a partial share issue. As was done successfully with the power companies.

The limping Kiwi dollar just got a spring in its step

With the risk of an immediate cut removed, the NZD strengthened half a cent on the USD on Wednesday.

But a strong dollar is no friend of the desired prospect of export-led economic growth.

Exporters drive this country. Their job in a trade-constrained world just got a bit harder as their goods are now slightly more expensive. But every cent counts when you’re selling volumes of commodities.

Of course, we investors are also biased.

A lower NZD on the back of a surprise OCR cut could boost not only the exporters but many NZX holdings.

But there’s no such luck this time.

Our actual interest rates are still comparatively high

 

New Zealand OCR 1.00%
Bank of England Base Rate 0.75%
New Zealand HSBC Mortgage (2 years fixed) 3.54%
UK HSBC Mortgage 75% LTV (2 years fixed) 1.29%

So, even though we’re only 25 basis points ahead of the UK’s wholesale rate, this bank mortgage example suggests a discrepancy of 225 points!

Bank margins may be much higher in New Zealand.

So be careful what you wish for. The OCR stays at an expected place. But structural problems remain.

Our economy is losing competitive ground. High debt remains a threat. As does the deep housing crisis in many areas.

A strengthening NZD won’t resolve the crunch exporters face from the turning Chinese situation. And the costs the ordinary person in the street faces to pay their mortgage and live day-to-day are galloping ahead of other developed nations.

The Reserve Bank doesn’t have too many levers. They’ve made a call balancing the factors. And looking for room to move in 6, 12, 18 weeks’ time…

Fixing the structural housing problem and overregulation that is threatening New Zealand’s economy is up to the government.

Some sweeping is needed in many areas.

Could the current broom be wearing thin?

 

Regards,

Simon Angelo

Editor, WealthMorning.com

 


Simon is the editor of Wealth Morning and has been investing in the markets since he was 17. He recently spent a couple of years working in the hedge fund industry in Europe. Before this he owned an award-winning professional services business and online learning company in Auckland for 20 years. He has completed the Certificate in Discretionary Investment Management from the Personal Finance Society (UK), has written a bestselling book and manages global share portfolios.


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