Rate Rises Are Coming, with Mortgage Fixing to Follow

• The RBNZ laid out the path for policy, including OCR rate hikes from mid-2022. Interest rates, including mortgage rates, have bottomed (all going well).

• We have pulled forward our forecast OCR hikes to commence from May’22. New Zealand’s monetary policy stance sticks out compared to the RBA, and most other central banks.

• There is significant upside risk to Kiwi interest rates and the Kiwi dollar. We are wary of mortgage related fixing in coming days, weeks, and months.

A “more confident” RBNZ signals two rate hikes next year, and a full normalisation in monetary policy back to 2%. The RBNZ’s statement was much more hawkish than we had expected at this stage. But we appreciate the clarity. The RBNZ delivered what we were hoping for, in the way of a crystal-clear OCR track. And they dumped the unclear, yet unconstrained track. The OCR track compares like apples to oranges when remembering the unclear “unconstrained” OCR tracks of the last two statements. We like them apples.

If all goes according to forecast, the RBNZ has signalled not one but two 25bps rate hikes next year (with 90% probability). And the path back to a “neutral” cash rate of ~2% is seen out to 2024.

We have pulled forward our forecast OCR rate hikes from November to May 2022. All going well, the RBNZ “may” be in a position to lift the cash rate from a rock bottom 0.25%. Of course, a move in May means a follow up move in August, and introduces the risk of 3 hikes to 1% next year. That’s the risk we believe is more likely to take the market from here. And we’d expect to see all interest rates rising in response.

The hawks were circling

Developments since the last MPS justified a more hawkish statement. We weren’t convinced the RBNZ would deliver one though. Despite the uneven nature of the recovery, the economy has been far more resilient to covid than first feared. Activity appears to have held up well at the start of 2021 despite the closed border, and the RBNZ’s prediction of a double dip recession may prove too bearish.

The global data flow has generally been stronger since February. So much so that the IMF once again upgraded its global growth forecasts. The IMF now sees the global economy expanding 6% this year, up from a previous forecast of 5½%. Covid-19 vaccines are being rolled out at pace in the rich world, and covid restrictions have been relaxed in our major trading partners. But covid continues to cast a dark pall over the globe. We’ve recently seen a major outbreak in India. And some previous halcyon centres of the pandemic, such as Taiwan, are experiencing surges in cases. Any outbreak creates the environment for the virus to mutate in worrying ways. NZ is far from out of the woods.

Global supply-chain issues, rising shipping costs and elevated commodity prices are all adding to near-term inflation pressure. However, these supply side factors should prove temporary and over the year ahead inflation is expected to fall back below the RBNZ 2% target midpoint.

The labour market has shown remarkable resilience, with the unemployment rate falling further to just 4.7% from a modest peak of 5.2%. But there remains measurable slack in the jobs market, with labour underutilisation high. The RB is closer but still short on their maximum sustainable employment mandate. And firms are finding it increasingly difficult to source skilled staff. The job vacancy rate hit a record level at the start of 2021.The closed border is creating issues around structural unemployment or a skills mismatch. Furthermore, labour supply shortage s may add further to inflation as firms compete for a limited pool of skilled labour – another supply constraint for the economy.

Since the February MPS, the housing market has shown ongoing vigour, and only limited impact from recent policy changes. Changes including the tightening of LVR restrictions, and tax changes targeted at investors. But it’s still early days and like the RBNZ we expect to see the housing market come off the boil in the coming months. House price growth should slow fast. But don’t expect a correction, as NZ continues to face a major housing supply shortage. Although the closed border is allowing the building sector to catch-up. Like us we are picking the trough in house price growth to be hit at the end of 2022.

Fresh forecasts, with tweaks here or there

The economy has been far more resilient to covid than first feared. And despite a closed border over the summer months, activity has appeared less adversely affected. The RBNZ has forecast another quarter of negative economic growth, which suggests another technical recession. But by definition only. And we’re not surprised. A slowdown in economic activity over the summer period is to be expected. We’ve closed the floodgates to international visitors, and at a time when foreign spend is typically at its peak. But who really cares about how 2021 began? We’re now approaching the final trimester of the June quarter. And March quarter aside, the Kiwi economy is firmly on the road to recovery.

According to the Reserve Bank’s new forecasts we’ve passed the peak in the unemployment rate. From here, we flirt around current levels (4.7%), inching closer to the pre-pandemic 4% over the projection period. The risk of deflation too has deflated given the surprising strength of domestic demand. Inflation is expected to overshoot the 2% target level in the near-term given base effects and ongoing covid-related supply disruptions. But as the narrative goes, current price pressures are “expected to abate”. There remains measurable slack in the jobs market, with labour underutilisation high. We believe the Reserve Bank, like most central banks, will wait for the labour market to fully recover, at the risk of some inflation, before tightening policy. Reminder, they don’t set monetary policy while wearing myopic lens. “The monetary policy Remit directs the MPC to “discount events that have only transitory effects on inflation, setting monetary policy with a medium-term orientation.” Nonetheless, an inflation rate above 2% is expected to be short-lived. However, with labour market conditions tightening, it places upward pressure on wage growth. And wage inflation is not as easily dismissed by the Reserve Bank as inflation generated by temporary supply disruptions.

On balance, the Reserve Bank is much closer to achieving its dual mandate than many of its peers and far sooner than previously believed. Nonetheless, the economic outlook remains uncertain and inextricably tied to how the pandemic progresses. Accordingly, the Committee stuck to its least regrets approach, noting a “preference to maintain the current level of monetary stimulus until [they were] confident that the inflation and employment objectives would be met.”, which would “require considerable time and patience”.

Market reaction

Financial markets reacted in a frenzy of NZD buying and rate paying. The Kiwi flyer was catapulted higher on the announcement, bursting through 0.73c (from 0.7230). Kiwi swap rates were lifted across the curve, as market traders looked to match (if not get ahead of) the RBNZ’s OCR track. The 2-year swap rate leapfrogged from 0.51% to 0.62%, while the 5-year jumped from 1.16% to 1.31%. These are big moves, that are likely to continue in offshore trading tonight.

As we highlighted on Monday, we are wary of mortgage-related fixing flow in the swap market. We said:

“It’s worth noting the short duration of Kiwi mortgages. 60% of mortgages are either floating, or up for refixing in the next 3 to 6 months. 80% of the mortgage book will refix in the next 6 to 12 months. That’s an enormous amount of fixing flow into a tightening cycle. Any pullback in rates should be used as an opportunity to get set (pay fixed). Just don’t tell the Australians…” Well now even the Australians know…and we may see a strong bout of mortgage related fixing in coming days as households (may) rush to lock in fixed mortgage rates.

By Kiwi standards, the aggregate mortgage book is as short as it’s (ever) been (under 1 year) and reminds us of the bout of mortgage paying in 2012.