INSIGHTS

Last week’s Monetary Policy Statement from the Reserve Bank suggested a rise in interest rates might be closer than many expect. It isn’t the only central bank making such noises, so borrowers and investors would be wise to take heed.

Unsurprisingly, the Reserve Bank struck an upbeat tone when talking about the economy. Dairy prices are close to a seven year high, unemployment has proved to be much lower than expected, business confidence has rebounded and the housing market remains very buoyant.

With that more optimistic outlook in mind, it’s hard to argue we need to keep monetary policy and interest rate settings at emergency levels indefinitely.

Official Cash Rate (actual and projected) %

The Reserve Bank appears to agree. Its forecasts suggest the Official Cash Rate (OCR) will start rising from its current 0.25 per cent in the second half of 2022, and that it will be back at 1.50 per cent by the end of the following year.

That’s still extremely low compared to history, but compared to current levels it’s a substantial increase.

The OCR isn’t the only thing that influences the mortgage rates we pay, but it’s a factor. If the OCR is rising, you can be pretty sure mortgage rates will too.

Financial markets have seen this change in sentiment coming and already begun to adjust. The five-year swap rate, an important benchmark interest rate in New Zealand, is at the highest levels we’ve seen since before the pandemic.

Similar moves are afoot overseas, and as a small country that still relies on a relatively high level of external debt we should take notice of what is happening elsewhere too.

Our Reserve Bank’s counterparts in both England and Canada have started pulling back on their bond purchase programmes, which is the first step to withdrawing stimulus and could be seen as a precursor to raising interest rates.

We'll be watching for similar moves from the Reserve Bank of Australia (RBA) in July, which could mark an important crossroads for Australian monetary policy. The RBA has said it will reconsider its bond yield target and review plans for its asset purchase programme (which is set to expire in September).

Then there’s the US Federal Reserve, the most influential central bank in the world. The Fed has been downplaying some of the inflationary pressures we’ve seen in recent months, reminding investors the US labour market isn’t as strong as it needs to be just yet. However, with the core personal consumption expenditures index (the Fed’s preferred inflation measure) having just posted the strongest annual gain since 1992 markets are getting a bit twitchy. Fed-watchers will also be monitoring this week’s monthly jobs report in the US.

With all of this in mind, borrowers should keep a close eye on mortgage rates, and seek good advice on how long they should fix for.

Don’t bite off more than you can chew, and acknowledge that just as falling interest rates have been great for house and asset prices, a reversal of this trend could see that tailwind become a headwind.

For investors, periods of rising interest rates are usually bad news for fixed income and bonds, although that doesn't mean these important assets should be ignored.

Much of the caution regarding bonds relates to the very long-dated, low yielding government bonds in places like the US, Japan or Europe.

Fixed income holdings in New Zealand are of a much shorter duration, which puts them at much less risk. Our market also leans toward corporate bonds, where yields are still reasonable and valuations not nearly as extreme.

A modest rise in interest rates would also bring a silver lining for many conservative New Zealand savers, as reinvestment opportunities would become more attractive.

Within shares, investors should ensure portfolios include companies that could benefit from an improving economy and increases in interest rates, as well as those with pricing power.

This article was also published in the New Zealand Herald on 30 May under the title "Is the super low interest rate tide turning?"