By Frank Newman on 11th September 2015
As expected, the Reserve Bank has reduced the Overnight Cash Rate (ORR) by 25 points to 2.75%.
The effect was immediate. The Kiwi dollar dropped 1 cent, which is good news for exporters, and a number of banks lowered their mortgage rates, which is good for borrowers but not great for savers with money in the bank.
Kiwibank and the ANZ cut their variable mortgage interest rate by 0.25% to 5.9% and 5.99% respectively, and the ASB Bank matched the 4.35% special one-year rate offered by the BNZ last week. That 4.35% is the lowest mortgage loan rate since the 1960s.
The two-year mortgage rate is the most popular and has until recently been the lowest rate on offer. The proportion of mortgages on floating rates has fallen from 60% in April 2012 to 26%. Now just over 60% of borrowers are on fixed rates of two years or less.
The commentary from the Reserve Bank identified three main risks to the economy: China, Auckland property prices, and drought.
About China they say, “The outlook for Chinese growth and demand is especially important, given that China accounts for about 18 percent of global non-oil commodity imports. The second largest consumer is the United States, at 7 percent.” What happens in China will have a material impact on the world’s economies, including ours.
On Auckland property prices they say, “We assume that house price inflation will ease steadily as new supply comes on-stream, but do not assume a sharp house price adjustment.” The average property price in Auckland is 9 times average income, which makes it one of the most expensive property markets in the world.
The Minister of Finance described the Auckland property market as being “on fire”. That’s a suitable warning because it is likely that those who pay a stupid price for a property will get burnt. In my view, the shortage of housing supply is largely due to restrictive planning regulations that prevent the free market from providing adequate housing at an affordable price. That problem will eventually be solved, and sanity will eventually return to Auckland’s property prices. Once that process has played out there will be quite a few sad homeowners who realise they paid too much.
Drought was the third factor mentioned by the governor, saying if a severe drought extended into autumn then it would impact economic growth. An El Nino weather pattern would bring below average temperature, rainfall, and soil moisture in the area Northland through to the Waikato. NIWA says there is a 90% chance of the El Nino weather pattern continuing into summer.
On the dairy sector, the Governor of the Reserve Bank commented that loans to the dairy sector account for about 10% of all bank lending. Debt to the dairy sector has increased from $12 billion in 2013 to $35 billion today. Only 10% of farmers account for a third of the total dairy debt while 20% account for about half.
In other words, banks are not heavily exposed to dairy sector lending when compared to their total lending and the high lending is concentrated in about 20% of the dairy sector. The Reserve Bank said the typical response by farmers to the lower income levels is (in order of priority) to:
1. Reduce drawings.
2. Delay capital expenditure until dairy prices rise.
3. Opt for cheaper feed, e.g. pasture or supplementary feeds such as palm kernel.
4. For farm owners, reduce labour costs by: returning to on-farm work; not increasing wages; and starting new workers on lower wages.
5. Increase cow culling, particularly of under-performing cows.
6. Increase technical testing to determine the most cost-effective use of essential products such as fertiliser.
7. Reduce spending on artificial insemination, and milk once a day.
While the Bank identified these three main negative influences, on the positive side it says, “Several factors continue to support growth, including robust tourism, strong net immigration, the large pipeline of construction activity in Auckland and other regions, and, importantly, the lower interest rates and the depreciation of the New Zealand dollar.” They believe the exchange rate will continue to fall in line with the decline in export commodity prices. The Bank is predicting economic growth of 2% over the next year.
The next OCR review is on 29 October. Ipredict puts the chances of a further 25 point decrease at 89%, and no change at 14%. What actually happens depends on the negative forces acting upon our economy but it is likely that the low-interest rate environment will continue through to at least the middle of 2016.