The other day, I was having coffee with a client when the conversation turned to interest rates, which isn’t unusual in my line of work. They looked at me over the café table and asked me the six-million-dollar question: ‘Why are we still waiting for interest rates to drop, Cam? When is it going to get better?’
Those questions got me thinking because it’s a good point. Why haven’t interest rates dropped yet? Because for the last 12 months, maybe even a bit longer, people, including myself, have been saying that interest rates will fall.
My short answer to that question is that despite predictions and the economic pundits saying the interest rate is going down (they keep getting it wrong!), the reality remains tough.
Why the delay in interest rate drops?
The fight against inflation plays a significant role in the delay.
It’s a bit like Newton’s third law: ‘Every action has an equal and opposite reaction’, which is a well-known statement in physics but applies to economics too. In economics, actions like government policies, changes in consumer behaviour, or shifts in global markets can trigger reactions within the economy. For instance, when central banks adjust interest rates or implement monetary policies to stimulate economic growth, these actions can have corresponding reactions to inflation rates.
So, inflation begins to ease as spending pulls back and demand decreases. While this is a positive sign, it comes with challenges, including job losses and reduced business activity.
What exactly is inflation?
One definition describes it as a gradual loss of purchasing power, and it’s reflected in a general rise in prices for goods and services. That’s a bit ‘glass half empty’ in my view, and I think it’s better described as a gradual increase in prices over a given period of time. The truth is that you do need a bit of inflation because it creates a natural incentive to purchase things now and that is a fundamental requirement for cash to flow through the economy and into people’s pockets. Imagine what would happen if the opposite of inflation was in play – people would stop spending in the hope that the things they wanted to buy would be cheaper tomorrow and the money flow would stop. So, inflation itself isn’t a bad thing but too much inflation certainly is. Inflation in New Zealand reached 7-8% last year, and we all noticed an increase in our weekly shopping trolleys and household bills.
In line with other countries, including the USA and the UK, the Reserve Bank wants inflation to be within a 0% to 3% range and aims to control it by increasing interest rates.
The fight against inflation is working, and inflation is buttoning off at the time of writing. We’re now into the 4% range, but it’s staying stubbornly high, which is why wholesale and retail interest rates are staying high – to keep sucking money out of your pocket so you can’t spend it and in turn create inflation!
It is painful—as most of us know! We’re all reining in our spending habits because we have to spend more on our mortgages. This is happening across the board, so if you look at spending intentions, such as eating out, buying a car, having an overseas holiday, or going to Kings Plant Barn and buying some gardening stuff, we’re just not doing that as much.
Now businesses are beginning to suffer because people aren’t spending, and employees are starting to lose their jobs. This will eventually push prices down and bring the rate of inflation down. There’s more pain to go through to get there, and as per the RBNZ’s pronouncement today (22/05) we still have to go through it for the rest of this year and probably into 2025.
High interest rates – hedge your bets with a split mortgage
Because we don’t know when interest rates are going to come down, the advice that we’ve always given our customers is to split the mortgage. Locking into a fixed-rate mortgage is recommended to avoid potential future interest rate hikes, and splitting your mortgage into fixed and floating-rate terms is also a good strategy.
Split your mortgage into a couple of fixed-interest rate loans at the very least, some fixed for a short period and some fixed for a longer period. That hedges your bets. If rates improve quickly then the short fixed rate will let you take advantage quickly but if rates take longer to improve (or get worse!) then you’ve got more certainty built in thanks to the longer fixed period.
While everyone is sure that interest rates will be no worse than what they are now and perhaps a little bit better as we look forward to Christmas and next year, the reality is that not one commentator or market boffin has ever got it right (not even me!). It means that the best and most wise strategy you can adopt is to spread your risk in this way.
There is some good news on the horizon
Here are some brief highlights, which I’ll expand on more in my next newsletter.
- Easing the CCCFA regulations
The first bit of good news is that the National Government is considering relaxing some CCCFA regulations to make it easier to get financing. - The upcoming lending review
Secondly, with an upcoming Loan-to-Value (LVR) review in June 2024, more positive change could be on the horizon for borrowers. - It’s becoming easier for property investors
Thirdly, recent changes in interest deductibility and the bright-line rule are significant for property investors. - Lots of new arrivals
According to provisional estimates released by Stats NZ in February, the December 2023 year saw an annual net migration gain of 126,000. More people arriving in New Zealand should be positive for the property market.
It won’t be quick, but it will happen!
To summarise, we can have all these positive variables, but they won’t come together until the interest rate changes later this year or early next. Then you will notice a change. And then things will get better.
If you want to discuss further, please get in touch and let’s have a chat.
