Black swans and grey rhinos coexist: where is the credit market heading in 2023?

New Zealand’s credit market in 2022: a review

 

2022 marked a turning point for economic activity in New Zealand.

Throughout the year, another round of US interest rate rises and balance sheet reduction saw the global economy transition from an era of inflation to one of deflation, and New Zealand could hardly remain insulated.

In 2022, the Federal Reserve raised interest rates 7 times in succession. The US federal funds rate rose from a range of 0–0.25% at the start of 2022 to 4.25%–4.5%, a cumulative increase of 425 basis points. This was the largest increase in 40 years, dating back to the 80s of the 20th century. As interest rates rose, US consumer price index (CPI) inflation fell from its peak of 9.1% in June 2022 to 6.5% in December 2022. However, inflation remained more than three times the Federal Reserve’s 2% target and continued to indicate broad-based increases in the general price level, particularly for services and housing.

New Zealand was the first country in the world to fire the starting gun on interest rate rises. The Reserve Bank of New Zealand began raising rates in October 2021, lifting the official cash rate (OCR) from 0.25% through 12 consecutive increases to 4.75% in February 2023. The cumulative increase of 450 basis points was also the largest in 40 years. However, the effect on New Zealand’s inflation rate was less pronounced than in the US. Despite 12 rate rises, New Zealand’s CPI inflation kept climbing, from 5.9% at the end of 2021 to a peak of 7.3% in June 2022, and remained elevated at 7.2% in December 2022. 

As interest rates continued to rise, New Zealand’s housing market also cooled in 2022. Figures for January from the Real Estate Institute of New Zealand (REINZ) show that nationwide house sales fell to their lowest level since records began in 1992: just 2759 homes were sold across New Zealand, including 943 in Auckland. The latest property figures released by government valuation agency Quotable Value (QV) on 9 March show that, as at February 2023, house prices nationwide had fallen 12.6% year on year, with the average price dropping to NZ$920,366. Auckland house prices fell 21.7% year on year, with the median price dropping below a million dollars, although prices remained around 24.5% above their pre-pandemic level.

Caption: As at February 2023, house prices nationwide had fallen 12.6% year on year, with the average price dropping to NZ$920,366. (Source: QV House Price Index)

Reserve Bank figures show that, as at December 2022, total outstanding mortgage lending, including lending by non-bank lenders, increased by NZ$613,000,000 to NZ$346,149,000,000. This represented growth of just 0.18% from the NZ$345,535,000,000 outstanding in December 2021. Of this, around NZ$310,500,000,000 was in fixed-rate loans and around NZ$35,000,000,000 in floating-rate loans, with an overall upward trend.

For business lending, the Reserve Bank of New Zealand said total outstanding lending fell again in January 2023, by NZ$754,000,000, including a NZ$607,000,000 decline in commercial property lending. This brought annual growth in outstanding business lending down from 7.9% to 6.7%.

Total outstanding agricultural lending increased by NZ$226,000,000, lifting annual growth from 0.3% to 0.5%. This was, in fact, the highest annual growth rate since December 2019.

From depositors’ perspective, the Reserve Bank’s latest figures show that total household deposits fell by NZ$1,100,000,000 in January 2023, the first decline since a fall of similar size in January 2022. This decline reflected substantial reductions in transaction and savings account balances. However, term deposit balances reached a new high, rising from NZ$104,987,000,000 in December 2022 to NZ$106,593,000,000.

Overall, 2022 was also a turning point for New Zealand’s credit market. Inflation’s continued rise and persistence at high levels forced the Reserve Bank to keep raising interest rates despite the risk of recession; after all, this was also its only means of controlling inflation. In addition, New Zealand’s unemployment rate remained low at 3.4% in December 2022, while real GDP held at 2%, giving the Reserve Bank confidence to continue raising rates.

 

New Zealand’s credit market outlook for 2023

 

Throughout the years，forecasting economic activity has been a fascinating topic, because in this era of coexisting black swans and grey rhinos, no one can be certain what next year will bring. Indeed, asking me in January this year for my forecast for 2023 could produce a different answer from asking me in March.

For an economy as relatively small as New Zealand’s, a single cyclone is enough to disrupt our economic forecasts for 2023.

The latest figures from economic consultancy Infometrics show that New Zealand’s economic activity was relatively solid before Cyclone Gabrielle arrived. Although aggressive interest rate rises by the Reserve Bank of New Zealand, a slowing property market, labour shortages and supply chain disruptions had already affected the economy, domestic economic activity in 2022 was stronger than expected. However, the sudden cyclone and flooding introduced a significant topic for New Zealand in 2023: recession.

The Reserve Bank of New Zealand’s Monetary Policy Statement, released in February 2023, said that core inflation and inflation expectations remained too high, while the labour market remained very tight. The global growth outlook was slowing, but a strong tourism recovery was pushing up domestic inflation. There were some signs that demand was beginning to slow as expected. In addition, recovery from the recent severe storms in the North Island could affect near-term inflation, short-term output volatility and medium-term economic activity. Higher interest rates remained necessary to meet its inflation and employment objectives, to the same extent as outlined in the November statement.

On inflation, New Zealand’s annual rate remained at a historically high 7.2%. ANZ economist Finn Robinson and chief economist Sharon Zollner noted that New Zealand was following the global trend of “the inflation impulse shifting from goods to sticky services prices”. Services prices were now contributing more than 2% to annual CPI inflation, with no sign of slowing. The domestic labour market remained hot, although the remarkable increase in net migration in recent months could ease some labour market bottlenecks. Easing labour market pressures would be key to understanding the direction of interest rates over the coming years. Meanwhile, the cyclone’s destructive effects were adding pressure to goods inflation in the short term. If this continued, CPI inflation would be unable to return to 2% even if goods inflation returned to historical levels.

 

On interest rates, the Reserve Bank said further OCR increases were still needed. It forecast an average OCR of 5.14% in the second quarter of 2023, and 5.5% or higher in the fourth quarter, with the OCR expected to start falling from the third quarter of 2024. Central banks around the world were entering a new phase of the rate-hiking cycle. Having rapidly raised rates to levels widely considered restrictive, many would slow the pace of increases and enter a phase of “fine-tuning” rather than “urgent catch-up”.

Caption: The Reserve Bank forecasts that the OCR will peak around the middle or end of this year, then gradually decline. (Source: February 2023 Monetary Policy Statement)

 

The Reserve Bank said it expected annual inflation of 7.3% in the first quarter of 2023, with a recession beginning in the second quarter of 2023. However, the latest figures released by Statistics NZ on 16 March 2023 showed that New Zealand’s GDP fell 0.6% in the fourth quarter of 2022. This decline followed unexpectedly strong growth of 1.7% in the third quarter, differed markedly from the Reserve Bank’s earlier forecast of 0.7% growth, and left annual growth across the economy at just 2.6%.

In economics, two consecutive months of declining GDP are defined as a recession. Many economists believe that, because of the lag in statistical reporting, New Zealand’s economy will enter recession earlier than the Reserve Bank forecasts, and that this recession is inevitable.

ASB forecasts that New Zealand’s economy will contract by 1% by the end of 2023, mainly because of reduced consumer spending and a decline in construction as the housing market cools。ASB chief economist Nick Tuffley said: “Inflation has proved stubbornly high, and we do not expect the Reserve Bank to bring it back to the 3% target level before mid-2025. Non-tradable inflation linked to domestic wage growth will push up businesses’ operating costs and could accelerate further before mid-2023.”

 

According to the latest Statistics NZ figures, 2777 new homes were consented in New Zealand in January, 86 fewer than in January last year, a decline of 2.0%. Compared with the same period last year, the decline in new dwelling consents in January was particularly pronounced in Auckland, at 11.5%. Although the nationwide decline was smaller, January was the fourth consecutive month in which consents were below the corresponding month a year earlier, indicating a slow but steady decline in residential building activity. These figures suggest that forecasts of future housing supply are also becoming less accurate: building costs have risen 13% over the past year, while house sale prices have been falling and are expected to continue falling over the coming year. How many developers would be willing to undertake developments at a time like this?

The key question for New Zealand house price forecasts in 2023 may be: when will prices bottom out? BNZ’s latest research report shows a strong negative correlation between house prices and interest rates. If rate rises slow and rates gradually peak, house price declines will also narrow and move closer to the bottom.

Caption: BNZ research shows a strong negative correlation between house prices and interest rates. (Source: BNZ QVNZ)

 

However, forecasts for the credit market in 2023, primarily the residential mortgage market, are often based on forecasts for all the economic indicators above. The credit market also tends to recover before the property market, because people generally decide whether to buy a home, for their own use or as an investment, based on their assessment of the broad direction of the global and New Zealand economies.

On 16 March, independent economist Tony Alexander noted signs that New Zealand’s property market could bottom out earlier, before the middle of this year. First, REINZ’s latest figures for February showed that New Zealand house prices rose 0.1% month on month in February. Although the decline in prices had not ended, its pace was clearly slowing. Second, net migration was continuing to strengthen, reaching a gain of 33,000 in the year to January, which is crucial for New Zealand’s housing market. Finally, the collapse of Silicon Valley Bank in the US was caused by a bank run resulting from a mismatch between short-term and long-term liquidity, rather than bad loans, and this wave of failures appeared to be spreading. The US interest rate curve was already falling, while New Zealand’s one-year fixed borrowing cost had dropped from 5.55% a week earlier to 5.3%. The 3-year borrowing cost had fallen from 5.25% to 4.75%. Growing discussion of a slowdown in monetary policy tightening would encourage more prospective homebuyers to rule out the worst-case scenario for interest rate rises, boosting market confidence.

For first-home buyers whose ability to service a loan can accommodate current interest rates, now is undoubtedly the best time to enter the market. During the soaring house prices of the previous two years, first-home buyers often came away disappointed from the frenzied auction market, despite securing larger bank pre-approvals than are available now. In the buyer’s market of 2023, investors are few and far between. Under the new DTI calculation method, first-home buyers may be able to borrow less, but with house prices falling and fewer competitors, their purchasing power may actually have increased.

For investment property buyers, although banks’ assessment rates ( Testing Rate) have risen, banks have recently introduced favourable interest rate offers, recognised a wider range of income types and gradually shifted their expense requirements from stringent to more reasonable. As Tony Alexdaner’s analysis above suggests, the property market could bottom out early, around the middle of this year, making now the time to prepare to enter the market.

For construction developers, this year the major lending institutions have relatively ample funds available. Experienced, professional developers who can offer housing that meets current market demand can still secure substantial funding support to keep their projects progressing smoothly. Meanwhile, many developers have chosen the Build to Rent model this year, and many banks have introduced loan products that meet this market demand.

In addition, alongside implementation of the CCCFA, the FMA requires that, after 16 March 2023, anyone providing regulated financial advice to retail clients must hold a Financial Advice Provider (FAP) licence issued by the Financial Markets Authority or operate under a FAP licence. Licensing places higher requirements and regulatory expectations on mortgage advisers going forward.

Plaxo Mortgage, a company specialising in mortgage advice and broking, was established in 2007 and has a history spanning 16 years. Its comprehensive service system and efficient workflows enable it to respond quickly to clients’ needs and provide the most suitable lending solutions in the shortest possible time. Plaxo Mortgage also has more than 10 professionally trained and certified licensed mortgage advisers with extensive practical experience. They are highly familiar with major financial institutions’ lending policies and procedures and can provide clients with highly professional, high-quality service. Whether you are buying a home to live in, investing or developing, you are welcome to contact a Plaxo mortgage adviser with any lending-related questions. We are confident we can provide you with the most professional mortgage service.