Opinion: Reserve Bank ignored as interest rates tumble

By Kate Perry of NZPA

Friday 19th November 2004

Fixed interest rates are tumbling as the country's major banks fight it out for fresh mortgage meat, undermining the Reserve Bank's efforts to put the brakes on the economy through wholesale rate hikes.

The central bank has raised the official cash rate (OCR) six times this year in an effort to reign in inflation caused by an overheating economy, by limiting discretionary spending powers. The bank is required to keep inflation between 1% and 3% "on average over the medium term." Inflation currently sits at 2.5%.

Raising the OCR usually flows on to the effective mortgage rate - the amount of interest paid on outstanding mortgage debt as opposed to rates offered to new users.

But the recent OCR hikes have not been met with the usual response in effective mortgage rates, mainly because of New Zealanders' preference for fixed interest rates, rather than floating rates. While changes to the OCR are felt in floating mortgage rates relatively quickly, fixed rate mortgages protect lenders until the term of their mortgage expires and they re-price.

According to the Reserve Bank, around 30% of fixed rate borrowings were due to come to term within the next year, while more than 50% were due to re-price in less than two years.

Last week, BNZ chief economist Tony Alexander said probably only about a quarter of home loans were on floating rates, down from 29% at the end of August.

The latest OCR hike was a 25 basis point rise in October. But instead of meeting this with corresponding interest rate hikes for home loans, the country's major retail banks have embarked on a full-scale lending war.

Leading the charge was the Bank of New Zealand (BNZ), whose two-year fixed rate of 6.9% barely hovers above the 6.5% OCR.

Last year the buoyant property market saw New Zealand's banks book combined profits of over $2 billion. But competition is heating up as they battle to to retain their slice of the property pie.

In mid-October BNZ drew a line in the sand with the-then low, low rate of 7.15%. In a nose-thumbing campaign, the bank touted its rate as `Unbeatable'.

Which it was. Until ASB took off its gloves last week with an offering of 6.95%. Every tit deserves a tat, which BNZ duly supplied, with a further reduction to 6.9%.

ANZ has also dropped its rate to 6.95%, and threw in some `steak knives' as well, by way of waiving approval fees and subsidising legal costs.

Westpac has kept its two year rate unchanged at 7.4%, but seems to be circling the battle with low 18-month and 30-month rates instead.

Westpac's New Zealand chief executive Ann Sherry recently told NZPA the bank was "not chasing the rates down as hard" as its competitors, saying she thought some of the rates on offer by the other banks were unsustainable.

Margins are being squashed as the difference between wholesale and retail rates diminish, but the bond market has been helping banks keep their heads above water.

New Zealand has a strong reliance on funds borrowed from offshore and BNZ currency strategist Sue Trinh said over $8 billion worth of eurokiwi bonds have been issued this year. Eurokiwi are bonds denominated in New Zealand dollars, but sold to European retail investors. New Zealand's high interest rate makes the debt attractive to Euro-zone investors where the official interest rate is a mere 2%.

While cash from debt-holding Europeans helps fund our property market, the Reserve Bank has expressed concern about the level of debt New Zealanders have gotten into in the past few years. Bank lending to households hit $91.4 billion in September, a massive hike from the $68.5 billion of two years ago. Reserve Bank deputy governor Adrian Orr said in a speech this week, rather than make use of the strong economy to build up a buffer against a potential dowturn, many households have leveraged up and invested heavily in areas such as property. He said in normal times households were capable of managing their debts. "But there is always a risk, albeit small, of a major economic shock that could leave many households without any income to service their debts."

The retail rate war kicked off after dovish comments by Reserve Bank governor Alan Bollard at the last OCR review in October. He indicated the tightening phase was over for the year, saying the full effects of earlier rate hikes had yet to be fully felt by the economy, while the high New Zealand dollar was also expected to help cool things down.

His comments went against market expectations of a further 25 basis point rise in December - which some speculate may still have to happen. A recent string of positive data shows the long anticipated economic slowdown has yet to appear, with retail sales up 2.6% in the September quarter, and unemployment at a 19-year low of 3.8%.

Chief executive of the New Zealand Property Institute, Conor English said another OCR hike could be on the cards.

"We still believe that the residential market will soften. However with inflationary pressure from several fronts and the current intense fixed interest rate competition, which is not assisting the Governor, he may take the opportunity to raise rates again in December," English said.

While the property market is expected to soften, a slump has yet to materialise. Figures out from the Real Estate Institute of New Zealand (REINZ) yesterday showed while property sales were down on the peaks hit at the same time last year, October volumes were up on the previous month, while median sales prices hit a new record high of $252,500.

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