"The interest rate hikes already delivered will have a huge impact on households," economists say
The Reserve Bank (RBNZ) is “hell-bent on hiking [interest] rates to hurt households” in order to meet its inflation mandate, according to Kiwibank economists.
Last week, the RBNZ announced a 75-basis-point hike, bringing the OCR to 4.25% – its highest level since 2008, with the central bank indicating a new peak OCR of 5.5% next year. The bank also signalled a recession to begin mid-2023, with Governor Adrian Orr admitting that the RBNZ was deliberately engineering a recession.
In Kiwibank’s weekly First View publication, chief economist Jarrod Kerr, senior economist Jeremy Couchman and economist Mary Jo Vergara said they believe “the interest rate hikes already delivered will have a huge impact on households,” interest.co.nz reported.
According to the economists, many mortgagees will see their discretionary income “evaporate,” especially for new homeowners who have entered the housing market in recent years.
“Some households will suffer significant financial stress as relentless rate rises push above the ‘test’ interest rates (around 6%) banks have used in recent years,” they said. “RBNZ rate rises are testing the limits, and consumption will ease. We’re wary the RBNZ may overtighten and cause a sharper correction, or a deeper recession, with a greater pull back in house prices.”
The RBNZ is now predicting a peak-to-trough drop of 20% in house prices.
“Demand must be restricted to meet supply. Inflation must return to the 1-to-3% target band,” the economists said. “On top of the current 4.25% cash rate, the RBNZ is signalling a further 125bps of hikes to come. The consequence looks likely to be a shallow but protracted recession from mid-next year.”
The economists expect mortgage rates to “be forced higher” in response to the OCR hikes.
“And these rapid-fire rate rises are coming at a time when many indebted households are rolling off fixed rates,” they said. “Previously fixed 1- and 2-year rates, locked in between 2% and 3%, are rolling off onto much higher rates between 6% and 7%. That’s a huge burden being lumped on top of households. For an $800,000 mortgage, the interest expense will rise from around $20,000 to $50,000.”
The economists, however, were expecting “more tightening over and above” that signalled by RBNZ’s forecast OCR track as the end of the funding for lending programme (FLP) – which provides banks access to relatively cheap funding at the same rate as the OCR – looms near (Dec. 6), interest.co.nz reported.
“The total impact could be between 15-50bps above the OCR projection,” the economists said.
Early in the pandemic, in 2020, the central bank moved “swiftly and aggressively” to keep the financial system afloat, they said.
“The OCR was slashed, billions of dollars of bonds were purchased under the LSAP [large scale asset purchases] programme, and the funding for lending programme (FLP) was introduced,” the Kiwibank economists said. “The FLP was especially effective in holding down bank funding costs. Both mortgage rates and term deposit rates fell during the introduction of the programme. The announcement of the FLP came in over August and November 2020, with the implementation in December. The success of the FLP was most pertinent when wholesale swap rates rose into 2021, and bank funding costs were held down.
“In the period after the GFC and before the pandemic, the spread between mortgage rates and wholesale swap rates was around 200-250bps. With the FLP, the spread compressed ~50-100bps.”
Once the programme ends next week, however, the economists said this will put upward pressure on wholesale bank funding rates.
“That is, raising funds will become a relatively more competitive and therefore expensive exercise for banks,” they said. “Term deposit rates are expected to rise. And that means more tightening above and beyond the projected 125bps of additional hikes to the cash rate.
“The exact impact of the FLP on wholesale funding rates is incredibly difficult to gauge. The total impact could be between 15-50bps,” they said. “But there’s potentially a lot more to come through if we return to pre-COVID levels. If total spreads were to return to pre-COVID levels we would see a lift of around 80-100bps – above the RBNZ’s forecast of 125bps in OCR hikes.”
The economists are now turning focus to the next OCR meeting on Feb. 22, interest.co.nz reported.
“And the RBNZ’s forecasts imply another 75bp hike in the cash rate,” they said. “However, given that other central banks have, or are about to, slow the pace of rate hikes we expect them to moderate their language. We suspect the RBNZ (along with every other inflation fighting bank) will be in a position to ‘pivot’, and slow rate hikes, with weakening growth and improved inflation expectations. We hope…”
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