By Matthew Gilligan - Gilligan Rowe & Associates
The Official Cash Rate (OCR) held high to quash inflation is arguably the medicine New Zealand needs to slow the economy. But there comes a point where high interest rates start pushing businesses over the edge and doing structural damage.
Businesses exit the economy, whether forced by a lack of sales, or insolvency. People cross the Tasman to find higher incomes and lower cost of living, including housing. The high rates do damage to households and our economy, if left in place too long.
It doesn’t help, in my view, that the Reserve Bank of New Zealand (RBNZ) dutifully churns out its reports quarterly, unlike other central banks which report monthly. By the time the RBNZ assesses the data, it is already old news. Imagine trying to steer a ship using last week’s weather forecast—it’s a precarious strategy.
Adrian Orr’s rollercoaster ride
As governor of the RBNZ, Adrian Orr has been at the helm and in my opinion has seriously over-reached in influencing the market over the last few years.
His interest rate manoeuvres resemble a rollercoaster. Firstly he oversteered interest rates too low, enticing house buyers with historically low rates (in the 2% range) and providing abundant liquidity. Now realising his inflationary mistake, he has yanked the rug out from under borrowers and pushed interest rates to decade highs.
It’s a hard landing for those on fixed incomes who borrowed at the peak. It’s hard on businesses as the RBNZ grinds spending down to reduce the CPI (Consumers Price Index).
The pain is being suffered because Orr has driven interest rates so low, then so high. A more moderate hand is needed; the volatility has come from the very institution established to moderate it.
The RBNZ seems blissfully unaware of the strain many businesses face at present. Orr’s interest rate decisions risk structural damage, pushing otherwise viable enterprises out of the economy. The lag in reporting is not helpful in making timely decisions.
DTIs: A controversial proposal
The RBNZ now want to introduce debt to income (DTIs) restrictions, limiting how much people can borrow for housing to a multiple of what they earn. Six times income for home lending, seven times for residential investment lending.
Finance for existing loans being refinanced, commercial property, new builds, and Kianga Ora low equity loans are to be exempted under proposals that may come into effect from the second quarter of 2024.
The rules are supposed to be a guarding rail on banking guidelines, to prevent exuberant lending during housing booms.
My question is, why do we need DTIs? Banks already stress-test borrowers at debt servicing ratios roughly equivalent to the proposed DTIs. New Zealand’s prudential lending code is working. Why add another layer of complexity? Is this another CCCFA debacle, unnecessary regulation? New Zealand banks are well respected globally for their stability and low default rates. Why do we need more regulation?
On a positive note, DTIs will stop housing bubbles forming and give the RBNZ another tool to control inflation, which might allow them to drop interest rates sooner.
So, while I am not a fan of centralised control and prefer a free market, there could be some light in the tunnel with DTIs in the form of interest rate drops happening sooner than they otherwise would.
In fact DTIs would allow a central bank to keep rates low, while constraining credit. But the RBNZ can already do this with LVRs and the OCR. So why do we need them?
Meanwhile, the pain is real for recent investors, first-time homebuyers, and those with low equity or income, already suffering from a three-fold increase in their interest rates.
They bear the brunt of loose monetary policy blunders from Orr. On the other hand, high-equity, high-income individuals remain relatively unscathed and will profit from the rebound. Hardly socially progressive behaviour from a central bank that strives to be a progressive institution.
The road ahead
As we navigate the second half of this year, I anticipate Orr will play catch-up and drop interest rates to give much-needed relief to our increasingly distressed economy. By early 2025, we should see rate relief following through to household purses, and a rebound.
It’s tempting when sales are falling, incomes become stretched, and market conditions become less favourable, to look and think short term. Has my house price fallen 20%? Will rates always be 8%? Will this go on for years to come?
To this I would say that what is happening over 2023-2024 is a snapshot in time.
Ask yourself, what will your customers be doing next year after interest rates drop? What will your customers do, having staved off replacing their capital, plant and investment decisions for several years? Having not upgraded their cars, their wardrobes, their domestic chattels wearing out? What will your house price be in five years, after the current dip?
Chin up, what goes down bounces back in recovery. We will be back on track by 2025; it’s just a waiting game for the hangover of excessive (Labour) government spending and loose lending policy from the RBNZ to wear off. Inflation is declining; it won’t be long before we will see much needed rate drops and confidence return, all things being equal.
In this regard, much of the surplus housing stock on the market (at present) is starting to represent real value. In adversity there is always opportunity for the brave. Counter-cyclical property investors investing in the down market get rewarded in the long run. You might consider taking a look at the housing market at present. Buy at the bottom, sell at the top. Its looking cheap out there at present.
I do think the good times will return within 12 months.
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