New Zealand may see a third rate rise tomorrow: what will homeowners, buyers and the construction industry face?

New Zealand’s inflation rate has fallen, but homeowners may face another interest rate rise.

At 2 pm on 28 October, the Reserve Bank of New Zealand will announce its latest Official Cash Rate (OCR) decision. The OCR currently stands at 2.75%, and economists at several banks expect the Reserve Bank to raise it by 25 basis points to 3%. However, the final decision has yet to be announced.

Data released by Stats NZ just last week showed that New Zealand’s annual inflation rate fell from 4.1% in the second quarter to 3.7% in the third quarter. If inflation has already eased, why are expectations of a rate rise growing stronger?

The reason is that the Reserve Bank must consider not only the data already released, but also how prices may move over the coming months. Rising oil prices, a weaker New Zealand dollar and the risk of costs flowing through to other goods and services could all cause inflation to pick up again.

Inflation has eased, but living costs are still rising

According to Stats NZ, the Consumers Price Index (CPI) rose 3.7% year on year in the third quarter of this year, down from 4.1% in the previous quarter, but still above the Reserve Bank’s medium-term target range of 1% to 3%.

Annual inflation was 4.3% for tradable goods and services and 3.3% for non-tradable goods and services. The latter are more heavily influenced by domestic costs in New Zealand, and their rate of increase remains elevated.

For ordinary households, a lower inflation rate does not mean prices have returned to previous levels. The 3.7% figure means overall prices are still higher than a year ago; they are simply rising more slowly.

Petrol was the largest single contributor to annual inflation in the third quarter. Although petrol prices fell from the second quarter, they were still 19.1% higher than in the same period last year.

This means that even with the improvement in the latest inflation figures, households still face pressure from spending on transport, food, electricity and housing.

Oil prices and the New Zealand dollar make future inflation harder to predict

Recent increases in international oil prices and a weaker New Zealand dollar are key reasons for economists’ renewed concerns about inflation.

New Zealand relies on imported fuel. When international oil prices rise or the New Zealand dollar weakens against the US dollar, fuel import costs may increase. Higher oil prices affect more than what drivers pay at the pump: they may also push up transport, delivery and business operating costs.

For the construction industry, a weaker New Zealand dollar may also increase the cost of imported building materials, equipment and components. The ultimate impact depends on suppliers’ stock levels, purchasing contracts, exchange rate arrangements and pricing practices, with different projects facing different pressures.

According to interest.co.nz, BNZ head of research Stephen Toplis believes that changes in both oil prices and the New Zealand dollar could push up future inflation, with the weaker dollar a particular cause for concern.

Some economists expect annual inflation to rise again in the fourth quarter of this year. ASB’s forecast is 4.7%, but this is only a forecast; the actual figure will not be known until Stats NZ releases the data.

Rate rises cannot lower oil prices, so why would the Reserve Bank raise rates?

What can a New Zealand interest rate rise achieve when international oil prices are rising?

The Reserve Bank cannot directly lower international oil prices by raising interest rates. But it is concerned that, as fuel costs rise, transport companies, suppliers and other businesses will progressively increase their prices, spreading the initial oil price shock across a broader range of goods and services.

If businesses and households expect prices to keep rising rapidly, those expectations may also influence business pricing and wage negotiations, making inflation harder to bring down.

Raising the OCR can dampen some demand in the economy by influencing borrowing costs, spending and investment. However, this also increases the burden on borrowers and could further slow already subdued economic activity.

Some economists oppose further rate rises

Although several banks expect the Reserve Bank of New Zealand to raise rates this week, economist Shamubeel Eaqub believes it should leave rates unchanged.

According to The Post, Eaqub is concerned that further rate rises while the economic recovery remains fragile could dampen already weak economic activity. He noted that current high interest rates are already affecting people’s home-buying decisions, while property investment activity is also relatively weak.

In his view, current price pressures largely stem from cost shocks, while the labour market and business conditions remain difficult. Raising interest rates further could add to the burden on households and businesses.

However, ANZ senior economist Miles Workman takes a different view. He believes that although headline inflation has fallen, the detailed data already show signs that the fuel price shock may be spreading to other goods and services, giving the Reserve Bank continued reason to consider a rate rise.

The key point of disagreement is this: If inflation pressures continue to spread, the Reserve Bank may need to act further; but raising rates too far could also slow the recovery in the economy and housing market.

Most banks expect a rate rise tomorrow, but views differ on what comes next

The Reserve Bank of New Zealand raised the OCR from 2.50% to 2.75% in September. If it raises the rate by another 25 basis points tomorrow, the OCR will reach 3%.

According to interest.co.nz, economists at the major banks generally expect a rate rise in October, but differ on the outlook for December and next year.

ASB recently forecast that the Reserve Bank could raise rates by 25 basis points each in October, December and February next year, ultimately taking the OCR to 3.50%. Other economists believe the Reserve Bank may pause after acting in October, waiting for more data before deciding its next move.

Tomorrow’s decision therefore warrants attention not only to the OCR itself, but also to how the Reserve Bank describes oil prices, the exchange rate and the inflation outlook.

If the Reserve Bank raises rates, that does not mean another rise in December is certain; if it leaves rates unchanged, that does not rule out future increases. Subsequent decisions will still depend on economic data and the Reserve Bank’s assessment of inflation risks.

Will mortgage rates rise immediately?

The OCR influences the interest rate environment, but banks’ mortgage rates do not necessarily move at the same time or by the same amount.

When setting mortgage rates, banks also consider wholesale funding costs, funding sources, market competition and expectations for future interest rates. If the market has long expected the Reserve Bank to raise rates, some of those expectations may already be reflected in banks’ current mortgage offers.

In an analysis for OneRoof, Cotality chief economist Kelvin Davidson noted that mortgage rates may not change significantly in the short term because financial markets already expect another rate rise.

However, if the Reserve Bank signals further rate rises more strongly than the market expects, or wholesale funding costs rise further, banks may still adjust their offers later.

For homeowners with fixed mortgage rates, the rate during their existing fixed term will generally not change immediately in response to an OCR adjustment. A bigger change may come when the fixed term ends and they need to choose a new rate.

For example, a homeowner currently locked into a low rate whose fixed term is about to expire will need to compare the new rates available at that point and assess the change in monthly repayments. For these households, when their mortgage reprices over the coming year may affect their budget more directly than tomorrow’s individual decision.

Do lower house prices make buying a home easier?

The interest rate outlook also affects the housing market.

Falling house prices may lower the barrier to entry for some buyers, but buyers need to consider more than the purchase price: mortgage rates, insurance, council rates, maintenance and other day-to-day expenses also matter.

If house prices fall while borrowing costs rise, some households may see little relief in their monthly repayments. For buyers taking out larger loans, even a small change in interest rates may affect the bank’s assessment and their final home-buying budget.

For developers, interest rates affect land holding costs, project financing and sales arrangements. The longer the development period, the more attention the impact of changing financing costs on the project budget deserves.

Construction businesses face similar issues: fuel, transport and imported material costs may increase, while orders may be affected if clients delay building because of financing costs or an uncertain outlook.

Of course, a single OCR adjustment will not immediately change all house prices and building quotes. Circumstances vary between projects, businesses and regions, but how long interest rates remain at their current level, and whether they rise further, will influence confidence among buyers and across the industry.

YIJU’s perspective

The fall in inflation from 4.1% to 3.7% is a positive development, but inflation remains some way outside the Reserve Bank of New Zealand’s target range. What happens next to oil prices, the New Zealand dollar and domestic costs will influence whether interest rates can stabilise.

For homeowners and prospective buyers, tomorrow’s OCR decision deserves attention, but they also need to consider when their own mortgage will reprice and whether their household budget can withstand changes in interest rates.

For developers and construction businesses, interest rates and building costs jointly affect project finances. Falling house prices do not necessarily mean housing is more affordable. Market confidence has a better chance of recovering only when purchase, financing and construction costs are all within affordable limits.