RBNZ will need to start taking its foot off the brake even before inflation has returned to the target, economist says
Mortgage borrowers are facing more hip-pocket pain this year, and this will drag down domestic demand as rapid price increases eat away at households’ spending power, Westpac economists have warned.
In Westpac’s latest Economic Overview, the bank noted that the impact of higher interest rates, which have shot up by a total of 450 basis points since the tightening cycle began in October 2021, is yet to be felt by homeowners.
“Homeowners with mortgages are now rolling onto much higher interest rates than before,” said Michael Gordon, Westpac’s acting chief economist. “That will prompt consumers to rein in their spending, and businesses to scale back their investment and hiring plans.”
Conditions for borrowers will become a lot tougher over the coming year, with nearly half of all fixed-term mortgages due to come up for repricing over the next 12 months.
Some borrowers who fixed for two years in early 2021 in the 2.5% to 3% range are now looking at a two-year rate that’s more than 3pp above what it was back then, the report said, adding that these big increases will “take a big bite out of many households’ disposable incomes.”
Someone who brought an average-priced house in 2021 with an 80% mortgage fixed for two years, for instance, would likely see their minimum repayments rise by around $530 per fortnight. That figure increases to around $900 per fortnight in Auckland, where house prices tend to be higher.
“On average, borrowers in this example would need to spend around 12% more of their disposable income to meet the minimum repayments on their mortgage,” Gordon said. “For many families, that would more than offset the growth in their incomes over the past two years.
“The combined impact of those higher interest costs, large increases in consumer prices and a weaker housing market will be a significant drag on demand. Many households will be forced to wind back their spending due to the mounting pressure on their finances, and many others will do so out of an abundance of caution. Putting that altogether, we expect to see per-capita spending levels falling by around 2% over the next few years.”
Household spending accounts for around 60% of total economic activity.
“In time, this will see inflation fall back from its highs,” Gordon said. “But it will be an uncomfortable wait in the meantime, with a number of disruptive forces adding to prices in the near term.”
The January floods and Cyclone Gabrielle have caused destruction that is difficult to gauge in the meantime, Westpac said. But given its scale, the economists expect rebuilding efforts to draw on the nation’s resources over several years and cost many billions of dollars.
“However, we should be careful about making too much of what this means for interest rates,” Gordon said. “The lesson from the Canterbury earthquakes was that conditions in the wider economy play a far greater role in determining inflation.”
“While the economy is running much hotter now than it was in 2011, we expect that to turn significantly in the years ahead as higher interest rates bite. And given the inherent lags in monetary policy, the Reserve Bank will need to start taking its foot off the brake even before inflation has returned to the target.”
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