After the relatively smooth run we had with economic conditions globally, I suppose it was inevitable something would come along to spoil it.
And first up it was something new - a 'novel' virus.
Now though we are seeing some decidedly 'not novel' factors coming on to the scene. Not 'novel' perhaps - but not seen for a long time either.
The return of initially one 'old villain' - the almost forgotten inflation monster - has now been followed by a re-acquaintance with another old villain - namely war. It's not clear yet whether this will be 'hot' or 'cold' war, but either way, between this and inflation these factors could collectively dominate the immediate economic future.
It's around 30 years or more since many of us have had cause to much think about or worry about either inflation or armed conflict. Now we have both of them back in the frame and the second one (the conflict) is likely to act as an accelerant for the first one (the inflation).
After two whole months on summer break I've been scrabbling to catch up on my background reading. One of the things that caught my eye was a piece from independent economic researchers Capital Economics regarding the Russia-Ukraine crisis. Capital senior global economist Simon MacAdam calculates that a Russian invasion of Ukraine or severe ratcheting up of sanctions would add "as much as" 2 percentage points to inflation in developed markets, particularly in Europe.
"In normal times, [developed market] central banks would ‘look through’ such a jump in inflation. But currently, this would be one of a long litany of inflation shocks that have conspired to push inflation already well above targets. So, we think that policymakers would be forced to tighten policy more than they otherwise would," MacAdam says.
Which is all pretty interesting, because it comes on top of already surging inflationary pressures that have been kicked off in large part by supply problems. And clearly any actual conflict or alternatively development of a new cold war (or combination of both) will see those supply problems made worse.
Either way you look at it, I think the portents are not good for the world being able to push the inflation genie back in the bottle any time soon.
And we here in NZ of course will not be immune to all this.
We have already clocked a three-decades high annual inflation rate of 5.9% as of the December quarter. Economists are suggesting inflation may peak at around 6.5% in the March, 2022 quarter. But bear in mind that economists' forecasts both in terms of how high inflation will go and for how long it will remain elevated have been going steadily up and up in recent months (as actual inflation has continued to blow forecasts out of the water).
Any additional inflationary stresses due to geopolitical risks will come on top of the considerable inflationary issues our Reserve Bank is already facing up. Already the assumption is it will raise the Official Cash Rate again at its next review on Wednesday, February 23, probably to 1.0% (from 0.75% currently). There's an emerging view that the RBNZ may hike the OCR at each of its seven reviews this year - which would take the OCR to 2.5% by the end of this year.
What would mortgage rates be looking like if that happened? Well, it's not as easy to answer that as you might want to think. It would not be a question of simply adding the extra 175 basis points added to the OCR on to average mortgage rates. Remember, the banks have been very much front-running anticipated rises in the OCR with their own mortgage rate hikes.
The RBNZ's monthly average mortgage rate figures show that as of June last year the average two-year fixed 'special' mortgage rate was a little under 2.6%. As of January 2022 the average rate had jumped to 4.25%.
The last time the OCR was at 2.5% was just over six years ago. At that time, according to our records here at interest.co.nz (and I'm talking end of January 2016) the average two-year fixed rate among the major lenders was a touch under 4.5%.
So, yes, the last time the OCR was a high as folks say it might get by the end of this year (IE 175 basis points higher than now), a two-year mortgage rate was only 25 basis points higher than the rates are already.
Now, I'm just guessing, but with the 'lead' the bank mortgage rates already have over the OCR I suspect we will see mortgage rates push rather higher than they were in 2016 if the OCR does hit 2.5% by the end of this year. Surely popular rates such as the two-year will go past 5%. Will they even go to 6%?
What levels of mortgage rates will the market - and more to the point the borrowers - be able to bear given the stupendous size of some of the mortgages we now see out there? There's the real question. And I'm sure that's a question the RBNZ would like to know the answer to as well. But the central bank will be concerned about the impact of its OCR hikes.
According to RBNZ monthly figures, in January 2016 the average sized new mortgage taken out that month was $167,000. In December 2021 (latest month available), the average-sized mortgage was $394,000.
The interest.co.nz calculator suggests that $167,000 taken out for 30 years on an interest rate of 4.5% (the average as of January 2016) would cost $846 a month to service. A mortgage of $394,000 taken out in January 2022 at 4.25% would be costing $1938 a month. Some fortunate people might have more than doubled their wages since 2016, but they would be in a minority.
The reality is things may already be getting tough, or about to get tough for recent homebuyers.
To quote Capital Economics again - they are already picking that there will be a 10% "peak to trough" fall in house prices in NZ by the middle of next year and that this will force the RBNZ to start cutting rates from the middle of 2023.
Falling house prices? Well, certainly the latest REINZ figures give substance to the anecdotal evidence of late last year that the housing market was coming to an abrupt halt.
How will this significant cooling of the housing market affect how people spend, particularly as we've now got Omicron circling in ever-wider circles?
The bad news is that that any significant drop-off in spending from here is not likely to have much of an immediate dampener on inflation. And the pressure for higher wages is continuing to build, which will of course also feed into more inflation.
Between Omicron disruptions, geopolitical risks and 'how high will it get?' inflation, this is looking like a strap-yourself-in kind of year. Just what we needed after the last two years...
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51 Comments
That's why parents shouldn't hesitate to help their children up the ladder. The less their children borrow, the higher their interest savings. That in turn prepares them to help their children or if they're enterprising expand the family portfolio.
I suspect if the banks gets too greedy or RBNZ gets over enthused, shadow banking will be back in fashion.
That said, there is still room for upward valuation.
Be quick!
CWBW - Love your commitment - but doubling down on bad advice doesn't improve its value. Keep going though as it makes my mornings fly by!
"New Zealand house prices fell by 1.5% in January after falling 1.1% in December. In Auckland average prices fell by 2.6% after falling 2.4% in December. "
CWBW,
I wonder, have you had to work hard at being unpleasant, or does it come naturally to you?
"I'd never seen anyone who'd gotten rich following how nurses make moolah". Surely even you must cringe to see c...p like this in print? The average salary for a registered nurse here is $66,000pa, with some earning up to $93,000. Hard to make moolah from that.
"There might be a strong underlying connection between nurses and poor financial performances." Apart from the sheer stupidity of that, it is deeply insulting to nurses, some of our society's most valuable members.
Just what service to society do you provide?
Investors actually finance builders in providing shelter. Having been to zillions of property auctions I can assure you that all sorts of people buy shelter, and not one sector monopolises it. We all know people who are the same age as ourselves, who have lived through exactly the same history, but who think things were totally different to how we saw them. The commenters on this article alone show that. It could be our own upbringing that influences us into the angle with which we look at problems and opportunities, difficulties and challenges etc. Great fun.
There is no room for upward valuation, the rise in valuation for last two years was due to ultra loose monetary policy and stimulus money making its way into housing market. This is a zero sum game now because
- If interest rates are raised to fight inflation then mortgage payments would increase leading to reduction in discretionary spending to pay for increased interest component of overleveraged mortgage payment thus affecting businesses and in-turn economy.
- Keeping interest rates low would increases inflation which affects 100% population leading to reduction in discretionary spending due to prices rise and to pay for fixed overleveraged mortgage thus affecting business and in-turn economy.
- Turning the immigration tap on to import workers to save costs for businesses by reducing wage demand will impact those who had planned on higher wages to pay their overleveraged mortgages.
If you try to save house prices then business and earners suffers. If you try to save earners then business and house prices suffer. And if you try to save businesses then earners and house prices suffer. Unless some miracle happens and inflation disappears.
If there is reduction in house value then major impact would be on the new entrants and that I guess won't be more than 10% of population.
The stars are aligning for something but not sure who would have to compromise.
Your assumptions is problematic and polar opposite of a more reasonable assumption list.
I suspect not. Anecdotally, my own four kids have bought five houses and two pieces of land in the last ten years. All through their own efforts. The important thing that Mum and Dad did was to teach them how to live a life so these things become possible. It's not rocket science, either.
No one in your real life must listen to this absolute dribble, so in desperation you seek an online forum as your last port of call, desperate for your voice to be heard.
Meeting headwinds on said online forum, you batten down the hatches and continue unabated.
At least your posts have a certain level of entertainment value, even if it decreases by the day.
It truly is.
The article considers the return of elements that have been completely foreign to most in these last few charmed decades. Recall 1992's 'The End of History' by Fukuyama, and Helen Clark's "benign strategic environment'' etc.
For many folk such as the above commenter they were gifted affordable housing supply thanks to the efforts of preceding generations, governments that shoveled money (extracted from following generations) to those houses they were able to buy cheaply thanks to their elders, debt-free entry to the workforce, and NZ's only universal welfare benefit in their old age.
Living off the wealth of preceding and succeeding generations, in a historically unusual time of prolonged peace. A charmed, comparatively easy life...while believing they did it all on their "own two feet!" Unsurprising a significant portion of them have a narrow vision of life.
Exactly right, not only does that money help its basically doubled because it saved you that same amount in interest. Could not have done it without help at the start but now chunks of money are flying at me but its no longer needed. It was totally life changing for me.
Chris Joye across the Tassie is suggesting that for the next 100 basis points increase in the OCR, expect house prices to come off 30%. It sounds extreme but that's what his modelling suggests. His models are replicated from those of the RBA.
All I can say about this is what if he's wrong? And how does that apply to NZ?
Seems very plausible to me if you look at the figures in the article above calculating just how much of a difference a rates move makes to weekly/monthly mortgage repayments. It won't be a question of FOMO anymore, FHBs simply won't be able to access the quantity of credit required to sustain the current prices.
I believe we're going to see persistent inflation and relative devaluation of the $NZ too, so that will eat further into what FHBs can afford to repay after living costs, *and* raise the borrowing costs of banks, forcing them to raise rates locally beyond OCR moves, *and* flatten discretionary spending, increasing unemployment.
Oh, and keep in mind that there are a huge number of existing mortgages rolling over every year who will be affected by the same dynamic. When US commentators talk about how rates changes affect the housing market -- we have to magnify that on both the upside and the downside because no one fixes the rate here. We've seen the untethered upside, and wasn't it fun... now maybe we get to see the inverse in action...
Is that the same modelling Aids modellers used? Sars virus modellers used? That bloke Ferguson in the UK used for Covid deaths? All absolutely and totally discreditted. Covid has taught me to be very cynical about a few people. All "experts", all "modellers", and the opinions of anyone who was on full pay during level four lockdown.
Good article.
2022 (the second half especially) will be a lot tougher than 2021, the core reason being INFLATION. The RBNZ can no longer ignore inflation and has to act, (I wouldn't be surprised if they raised by 0.5% next week. Higher interest rates at a time of record high mortgages will seriously hurt. Add the higher cost of living, the end of free government money in the form of Covid subsidies (this is majorly underestimated in my view) and it's clear a lot of Kiwis are going to reduce their spending significantly. This in turn means less people at restaurants, clothing shops, other retail shops, all these businesses that have already suffered a lot in 2021 but won't get government help anymore. Quite a few of these businesses will close which, of course, means that people working there will lose their jobs. These people will stop spending altogether. Add dropping house prices and I see the second half of 2022 in NZ as a real mess
Add the higher cost of living, the end of free government money in the form of Covid subsidies (this is majorly underestimated in my view) and it's clear a lot of Kiwis are going to reduce their spending significantly. This in turn means less people at restaurants, clothing shops, other retail shops, all these businesses that have already suffered a lot in 2021 but won't get government help anymore.
Yes. This is all consistent with the 'doom loop' as it relates to consumption and the bubble. They both feed off each other.
As previously mentioned, the high interest rate 1980s were hilarious. A lot of money made. A lot of entertainment. Only went broke once. Wouldn't have missed it for quids. One borrows a million at 18%. The security goes up at 15% per year for 5 years. 1.2million security is now worth 2.4million. One has paid 0.9million in interest. Result, happiness. Happened all the time then. These good times are just around the corner again!
Despite being in the fortunate position where we need not worry, we have still cut back spending quite a bit with further plans to trim this year. I just refuse to pay the ridiculous prices for some items, it is that simple. And it is clear those on a tight budget will be forced to cut back. You cannot spend what you don't have.
Anyone that's taking the proverbial on prices we just ignore, too. We've always been value-oriented despite also being in a fortunate position and on the right side of the RBNZ Welfare for the Wealthy scheme...but I have no desire to overpay for someone's silly knick-knack made for peanuts in a factory overseas. Don't have a knickknackatory to put them in either.
"...$167,000 taken out for 30 years on an interest rate of 4.5% (the average as of January 2016) would cost $846 a month to service. A mortgage of $394,000 taken out in January 2022 at 4.25% would be costing $1938 a month. Some fortunate people might have more than doubled their wages since 2016, but they would be in a minority."
However you don't have to double your wages to pay another $1,100/mth in mortgage payments though.
I'm pretty sure you would 'only' need a $13,000 after tax pay increase.
What levels of mortgage rates will the market - and more to the point the borrowers - be able to bear given the stupendous size of some of the mortgages we now see out there?
Haven't the banks been using a "stress test" interest rate of 6% or 7% to qualify borrowers since around 2018?
If so that implies MOST borrowers can cope with interest rates around those levels maybe?
Thanks David for the interesting article.
It appears the Ukraine situation has significantly increased risk of higher energy costs & a longer period of inflation.
The Reserve Bank’s job to keep inflation between 1% & 3% appears to be getting a lot harder. Some economists are predicting we won’t get back to this target within 10 years? Is that acceptable?
Why aren’t our politicians discussing this?
Maybe some heads should roll for this predicament we are in?
"inflation shocks that have conspired to push inflation already well above targets". Sorry, but "inflation shocks"? As soon as the RBNZ started printing money, what did you expect? How can inflation be considered a shock? Robertson was warned by Orr that easing would create inflation. Neither of those two should be anywhere near the jobs they are in, but at least Orr spelt it out to Robertson.
And you go on to say "surging inflationary pressures that have been kicked off in large part by supply problems". Of course, no one could have predicted that production would not keep up with surging demand as bad money flooded the market. I mean no one. It's not like its Eco 101 is it?
Sheesh.
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