Nationwide lockdown expected to end by October, with another wave of interest rate rises potentially awaiting the housing market!

As of today, New Zealand has recorded nearly 300 community cases following the arrival of the new Delta variant, with close contacts expected to number around ten thousand or more. Given the current outbreak, this year's nationwide battle against the virus seems only just to have begun. How will New Zealand's economy perform in the second half of the year, how will the Reserve Bank respond to this outbreak, and what turbulence lies ahead for financial markets?

 {ad}

Sudden outbreak puts OCR increase on hold

Last week, before New Zealand suddenly entered lockdown, the industry widely expected the Reserve Bank to raise the OCR substantially this month, but the unexpected outbreak ultimately prompted a last-minute announcement that the OCR would remain unchanged at 0.25. Although markets had already anticipated this extremely dovish decision, it still drew a strong reaction.

Economists agree that mortgage rates will rise further even if the OCR remains unchanged at 0.25 during the outbreak.

Commenting on the outbreak, ASB senior economist Chris Tennent-Brown said,

“The Reserve Bank was absolutely right to pause OCR increases, but that does not mean the OCR will stay low indefinitely. An increase this year remains highly likely, and mortgage rates are expected to rise further.”

Last month, before the Reserve Bank of New Zealand announced a series of monetary tightening measures, major local banks had already raised their fixed mortgage rates. With bank rates approaching three per cent, economists still consider current mortgage rates historically low.

The industry and economists share a consensus that more interest rates will begin rising in the second half of this year.

At yesterday's press conference, New Zealand Finance Minister Grant Robertson offered an upbeat assessment of the current outbreak and economic situation. He said,

“New Zealand's economy is currently in good shape, with unemployment at 4% and net debt below expectations. New Zealand has sufficient funds to support people through lockdown.”

This also sends an important signal about whether the Reserve Bank will raise interest rates next. The implied message can be interpreted as follows: The Government is confident in New Zealand's current economic conditions, and raising interest rates to tighten monetary policy has become inevitable.

The Reserve Bank's pause on OCR changes is only temporary. Chris Tennent-Brown believes, “Despite the current community outbreak of Delta, we still expect the OCR to peak at 1.5% by the end of 2022, with mortgage rates around 1% to 2% higher than they are now over the next few years.

Although the Reserve Bank is firmly committed to raising the OCR, mortgage rates over the next 10 years will remain well below the long-term average of the past 20 years. Borrowers should recognise that even a small rise in mortgage rates will mean a significant increase in repayments.

If mortgage rates rise over time from 2.5% to 4%, a borrower buying a property at the average house price of NZ$920,000, with a 20% deposit and a 30-year mortgage, would face an increase in fortnightly repayments of about NZ$280, or nearly NZ$7300 a year. That is a substantial additional expense.

More rate rises lie ahead

Independent economist Tony Alexander said, The community outbreak means some economic factors have changed, but borrowers waiting on the sidelines may be disappointed. Keeping inflation stable is now the Reserve Bank's top priority, and inflationary pressure is much greater than in March last year, so rate rises still lie ahead.

Although lockdown may mean OCR increases are gradual, mortgage rates will continue rising over the medium to long term. Although we do not yet know how long lockdown will ultimately last, the Reserve Bank of New Zealand's decision to hold the official cash rate, or OCR, at 0.25% is sufficient evidence that increases have merely been delayed. The Reserve Bank is highly likely to begin raising rates in October this year, when most borrowers' mortgage contracts expire.

Our experience of the pandemic over the past year shows that economic activity tends to rebound rapidly once lockdown restrictions are lifted. If this happens again, an overheating economy could expose the Reserve Bank of New Zealand to more persistent inflationary pressure. 

BNZ head of research Stephen Toplis calculated how long the Reserve Bank would delay OCR increases, based on an estimated lockdown timetable:

Assuming the whole country remains at Alert Level 4 until 31 August, and restrictions then ease by one level every fortnight, the country would not reach Alert Level 1 nationwide until mid-October. In other words, the Reserve Bank is highly likely to begin raising the OCR in October this year.

Unless this outbreak completely destroys the Government's confidence in New Zealand's economy — which is unlikely given last year's economic resilience — there remains a strong chance that the Reserve Bank will raise the OCR substantially.

 

Monetary policy will gradually return to normal

Monetary policy normalisation will inevitably be a trend and direction this year. A gradual return to normal monetary policy settings should be highly likely; that is the overall assessment.

Reserve Bank Governor Adrian Orr has repeatedly expressed concern in the media about the domestic economy overheating, and pandemic lockdown restrictions will not prevent him from raising interest rates unless there is a major, sustained shock to economic demand.

Kiwibank economists say the wage subsidy should soften the economic blow. If lockdown is brief, its economic impact will be relatively limited. Once restrictions ease, economic activity will rebound and the Reserve Bank of New Zealand will move quickly to raise rates.

The industry and economists widely regard a rate rise in October as a certainty, with only a much longer lockdown likely to change that direction. The economic losses from a lockdown lasting 2 to 4 weeks are manageable. People also hope the Reserve Bank of New Zealand can withdraw monetary stimulus to stabilise current economic conditions.

Monetary policy now needs to normalise to ensure the economy returns to a sustainable growth path.

Conclusion

Health measures and the fiscal response are currently the focus. However, given the high transmissibility of the new Delta variant worldwide, a global consensus seems to have emerged: living with the virus over the long term. New Zealand's ability to remain untouched has almost become a thing of the past. Rolling out vaccines and reducing community outbreaks will now be the Government's major pandemic tasks.