The view from peak OCR

The Reserve Bank has indicated that 5.5% is as high as the official cash rate (OCR) would have to go – although it would probably have to stay at this level through much of next year. Susan Edmunds reports.

As he responded to reporters this week about the impact of the central bank’s actions on households around the country, Reserve Bank Governor Adrian Orr bit back at one question.

‘‘Can I remind you that it’s a committee decision,’’ he asked. ‘‘I’m feeling very personally attacked here.’’

Although Orr earlier expressed some satisfaction about being able to talk through data that showed an improvement in the inflation picture for the first time in a while, many of the questions that followed were still focused on the negative.

Did he take responsibility for the interest rate crunch? What would he say to scared borrowers?

Interest rates have risen at a breakneck pace in the past two years, as the Covid money tap was turned off.

This week, Orr indicated that the 25bps increase to 5.5% was as high as the official cash rate (OCR) would have to go – although it would likely have to stay at this level through much of next year.

So where does that leave us?

Interest rates

The most visible impact of the interest rate tightening has been on homeowners, particularly first-home buyers who took out large mortgages in recent years.

Many have seen per-month repayment increases of more than $1000.

Orr said he did not expect the OCR increase this week to have an impact on interest rates offered by banks because the 25 basis point hike that the bank implemented had been signalled for some time.

He said the move was supportive of the current level of mortgage rates.

But BNZ chief economist Mike Jones said wholesale rates and the New Zealand dollar had risen on the expectation that the rate might need to peak at 6% to get on top of the heat in the economy. The decision to stick with a 5.5% peak had been a surprise to some.

‘‘By serving up a large surprise to the market, the Reserve Bank sent both screaming back down again. This effectively delivered an immediate easing in financial conditions and may well have headed off further increases in retail interest rates.’’

He said the debate would shift from how high the OCR would go to how long it would remain there.

‘‘The Reserve Bank was at pains to point out rate cuts are a distant prospect. We agree but have retained our forecast for a May 2024 start to the easing cycle, roughly six months earlier than the bank’s projections.’’

He said that while the OCR had probably peaked, the process of past interest rate increases working their way through the economy would continue.

‘‘The average mortgage rate actually paid by mortgage holders across the economy is still ‘only’ around 4.7%. We expect this to rise above 6% by year-end.’’

Jarrod Kerr, chief economist at Kiwibank, said interest rates had peaked and would start to fall by the end of this year.

Tony Alexander, an independent economist, said he did not expect to see any change in fixed interest rates now, although some banks had shifted their floating rates.

‘‘For me, the significance is that it’s going to lead people to stop worrying about interest rates rising further.’’

Westpac chief economist Kelly Eckhold, who had predicted a 6% peak for the OCR, said there was still a risk that migration would be more inflationary than the Reserve Bank expected, and more increases could be needed, particularly if the housing market fired up more than expected.

‘‘We can see a scenario where it increases inflation a bit further out in the track and it takes longer for inflation to go back in the target range.’’

He said Westpac had also pushed out when it expected interest rates to drop. ‘‘If you don’t do as much tightening now then you have to think about some way of compensating for that in the forecasts. One way is to stay tighter for longer.’’

House prices

While there is little dissent about the fact that prices had become much too high, the rate at which they have fallen has surprised some.

House prices have dropped 17% from their peak in late 2021, according to Real Estate Institute data. In some centres, such as Auckland and Wellington, the fall has been more pronounced.

In November 2021, the median national house price was $925,000, up from $747,000 a year earlier. In November last year, it had fallen back to just over $800,000.

That has been particularly tough on first-home buyers who bought at the peak or soon after and could have seen even 20% deposits swallowed up by house price falls.

This week, Orr said he was increasingly comfortable with where house prices had returned to. Strong net migration helped explain aggregate demand for housing, he said, which helped. ‘‘All we know is that house prices are much closer to their sustainable levels.’’

He said that did not mean houses were ‘‘affordable’’ but that their prices were able to be explained by fundamentals, such as the rent versus buy equation and demand against supply. ‘‘Prices are much better anchored towards those, that is a pleasing situation.’’

Some commentators had pointed to signs that the housing market might have been starting to find a floor before the Reserve Bank announced its decision.

The Real Estate Institute’s house price index has shown a slowdown in the rate of annual price decline in recent months, from a drop of 14.2% in February to 12% in April. CoreLogic reported a 0.6% monthly fall in April, but after 1% drops in February and March. It said it was less than the average monthly fall this cycle so far, of 0.9%. There were reports of Auckland auction clearance rates improving.

UBS economist Nic Guesnon said earlier this week that the bank believed prices had fallen as far as they were going to go.

Westpac also said a trough was approaching faster than anticipated and prices were likely to bottom out by midyear.

Jones said that in and of itself, the decision to call time on the OCR tightening cycle was not likely to lead to a big boost in the housing market because interest rates would remain high and banks were still testing at relatively high rates. ‘‘That’s a pretty high hurdle for new borrowing that will keep a lid on all things housing market. Pre-Covid, prices are still up 19%, alongside rents, incomes and international equivalents, we still stand out as very expensive. It’s not as if houses are suddenly cheap, by any means.

‘‘We’re not of the view that things are about to race away . . . but a bit more life in the housing market is one risk that we’re thinking about now that we are seemingly at the end of the rate cycle and have a migration boom occurring.’’

Eckhold said there was the potential for migration to be a more significant driver of the housing market than the Reserve Bank expected.

‘‘Our base case is that the housing market has bottomed and we would expect to see house prices starting to rise but no faster than general inflation in the next few years. But there’s a risk that we get a bit more house price inflation than that because there is quite strong growth in population from migration.’’

He said although house prices had fallen significantly, property was still overvalued on a lot of measures.

‘‘But the size of the population growth is really strong – 2.5% is the highest since 1961. You can’t discount that, because it’s really large. I think we’re going to learn a lot by looking at how the market responds over the next six months.’’

Australia had also experienced strong population growth and had recently experienced relatively strong growth in house prices, he said. ‘‘It may well be the case that Australia is a few months ahead

of us. They’ve got rents and house prices rising over there.’’

Kiwibank chief economist Jarrod Kerr said the market was ‘‘forming a base’’ and agreed population growth would be a big driver. ‘‘Come spring, activity is going to be picking up again. I think we’re forming a bottom here.’’

He said that even if migrants were renting, they would put pressure on the housing market, and some would buy. ‘‘There’s increased demand just because there is an increase in the population and there’s been quite a surge.’’

He said he was more confident that house prices would start rising again next year on the back of a rising population and lower interest rates. ‘‘There are some tailwinds coming.’’

Alexander said there was a ‘‘two-year queue’’ of people who had held off buying who would get back into the market when the time looked right. But he said the circumstances were not right for that yet.

Migration impact on inflation

Inflows of new migrants exceeded departures by 65,000 in the year to March. That compares to a net outflow of 20,000 people in the previous year. Westpac economists expect that net migration will rise to an annual inflow of 100,000 people by the end of this year.

The Reserve Bank has been relatively ambivalent about this factor, noting that migrants could help with supply issues as well as boosting demand.

Deputy governor Christian Hawkesby said this week that the bank took the view that those people had already arrived, and had not stopped the economy cooling.

The bank expected the pace of immigration to ease to pre-Covid levels over the coming quarters and settle at an inflow of 36,000 working age people a year.

‘‘While the recent increase may partly reflect some pent-up demand to migrate to New Zealand, immigration rules have also been eased to alleviate acute labour shortages in some sectors,’’ the bank said in its monetary policy statement.

‘‘The Government recently made it temporarily possible for some migrants on work visas who had already been living in New Zealand for a period to apply for a special resident class visa. Given these new residents would have already been participating in the economy and the housing market as renters, it is expected this change will add only modest pressure to housing demand.’’

And what about that recession?

Treasury now expects New Zealand will avoid a recession while the Reserve Bank still expects a small one.

Jones said weak retail statistics out this week indicated that the chances were ‘‘pretty high’’ that a recession would be confirmed in the middle of June.

‘‘I’m still of the view that the recession will be relatively mild and short-lived. All the extra people in the country will certainly support the activity side of things. As has been warned, on a per capita basis, the picture is still pretty sluggish around the economy. We’re seeing some of the pain of those higher mortgage rates as they feed through the economy, the mood is a lot more cautious out there . . . aside from the will we, won’t we in terms of the recession debate, there’s no doubt the economy is going through a reasonably painful adjustment.’’

Alexander said it was a 50/50 call whether there would be a recession. ‘‘In a way, you look at Treasury – no recession – Reserve Bank – tiny recession. Meh. Either could be right. I see the difference in what they see there as consistent with the toss of a coin.’’