LVR restrictions are finally set to ease, and a rate cut is not far off. But mortgage rates may not fall!

The Reserve Bank of New Zealand fired the first shot in interest rate cuts among Western countries! But Australia's central bank has since overtaken it, firing twice in succession!

 

Following its rate cut on 4 June, Australia's central bank yesterday announced another cut of 25 basis points. Australia's OCR now stands at 1.0%, another record low.

 

 

Australia's rate cut has greatly increased the likelihood of the Reserve Bank of New Zealand cutting rates in August. Some analysts even believe the prospect of three New Zealand rate cuts this year has increased.

 

Yet a series of recent statements from the Reserve Bank of New Zealand suggests it is deeply conflicted, caught between a rock and a hard place!

 

First, a look back at recent events in New Zealand

 

1. The Quarterly Survey of Business Opinion released on 2 July shows that New Zealand business confidence continues to decline, with businesses experiencing their most pessimistic period in 10 years.

 

With business confidence this low, the Reserve Bank must be considering a rate cut to provide some stimulus. After all, it hinted at a possible cut at its last meeting.

 

2. LVR lending restrictions could be eased:

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On the morning of 30 June, Reserve Bank Deputy Governor Geoff Bascand hinted at easing LVR restrictions while attending the University of Otago's 54th Foreign Policy School.

 

Geoff Bascand said the Reserve Bank favoured further easing loan-to-value ratio restrictions on home lending.

 

Reserve Bank of New Zealand Deputy Governor Geoff Bascand

 

“We would like to see household debt levels and house prices remain stable. If those conditions can be met, we believe LVR policy can be eased further, although that will also depend on an assessment of the risks.”

 

The Reserve Bank of New Zealand will publish its Financial Stability Report for the second half of the year in November. Industry observers see Geoff Bascand's remarks as a strong signal that the Bank will ease LVR restrictions in November this year.

 

3. Easing LVR restrictions will certainly free up more lending. Yet the Reserve Bank is also proposing that New Zealand's commercial banks increase their capital reserves, clearly putting the brakes on lending!

 

The Reserve Bank of New Zealand wants commercial banks to raise their minimum capital reserve ratio from the current 8.5% to 16%. In effect, this requires banks to increase their capital reserve ratios to withstand a once-in-200-years risk.

 

New Zealand's four major commercial banks have explicitly opposed the move, warning that it would lead them to raise interest rates by up to 1 percentage point.

 

Westpac also warned that the Reserve Bank's policy could increase annual borrowing costs in Auckland by NZ$6000 and have a “significant negative impact” on the economy.

 

 

The Reserve Bank will announce its final decision on whether to increase capital reserve ratios in November.

 

Why do the Reserve Bank's decisions contradict each other?

 

Easing LVR restrictions and increasing capital reserve ratios would produce completely opposite results. Why is the Reserve Bank contradicting itself?

 

We may find the answer in the Deputy Governor's remarks at the University of Otago.

 

Geoff Bascand said easing LVR restrictions depended on household debt levels and house prices remaining stable. Yet once monetary policy opens the floodgates, house prices will inevitably rise.

 

The lesson of Australia's sharp house price falls is right before us. That is why the Reserve Bank of New Zealand is struggling with how to stimulate the economy while keeping house prices stable.

 

So what changes might we see next in the mortgage market?

 

1. LVR restrictions may be eased slightly, particularly for first-home buyers.

 

2. The Reserve Bank is very likely to cut rates in August. However, higher capital reserve requirements may mean mortgage rates do not fall immediately, although they are already at historic lows.

 

Property speculation cost the National Party power, while curbing it is making New Zealand's economic performance look increasingly bleak.

 

What a dilemma!