Interest rates and payouts

There have been a number of news items of late that are worth comment.

Last Thursday the Reserve Bank left the Official Cash Rate (OCR) unchanged at 2.0%. There was no surprise in that, and in many respects the announcement confirmed expectations that the OCR is likely to be reduced further. Most commentators expect the next cut to be to 1.75% in November, and again in February to 1.5%.

That gives property investors ample opportunity to manage their mortgage strategy and look for the best window to switch to long-term fixed rates. Many borrowers have taken a short-term approach in recent years to take advantage of the lowest rates at the one and two year fixed terms, but the time will come when rates reach floor level and borrowers will switch strategy to the three and five year terms at under 5%.

The immediate priority of the Reserve Bank seems to be the value of the NZ dollar. They put it this way. “Weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate…the high exchange rate continues to place pressure on the export and import-competing sectors and, together with low global inflation, is causing negative inflation…A decline in the exchange rate is needed.”

The important point is our interest rates are still relatively high, against other countries. This has remained the case for quite some time because international interest rates have remained low for longer than expected, and just this week the US Federal Reserve decided against increasing rates at this time.

As a result, foreign investors are buying NZ dollars to invest in our money market. That demand bids up the value of the NZ dollar. A high dollar makes imports cheaper and reduces the NZ$ income of exporters.

The side-effect of low interest rates is a debt fuelled property boom, which remains a concern for the Reserve Bank. It says, “House price inflation remains excessive, posing concerns for financial stability. There are indications that recent macro-prudential measures and tighter credit conditions in recent weeks are having a moderating influence.”

Just how moderating those controls are remains to be seen, but most commentators are expecting property prices to remain strong, more so in the provinces than Auckland.

Long-term, the economic strategy appears to be about transitioning economic growth based on construction, to international trade – tourism and primary production in particular. A lower exchange rate will be critical to achieving that.

Dairy farmers will be welcoming the announcement from Fonterra that it has lifted the 2016/17 forecast Farmgate Milk Price by $0.50 to $5.25/kg of milk solids. This is the highest price in two years and its second upgrade in less than a month. Farmers can be confident that the recovery is now underway. Most dairy farmers need about $5 per kilo to cover costs.

The increased payout will add just under $1 billion to farming revenue. While farmers are likely to favour debt repayment, some of that money will flow through to local economies.

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