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Weekly Commentary

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The inflation targeter who wasn't

Fri, Sep 19 2008, 13:42 GMT
by Westpac Institutional Bank Team

Westpac Institutional Bank

The RBNZ surprised the market again by delivering a 50bp rate cut, the first time under Dr Bollard’s governorship. The RBNZ has decided to deliver some immediate relief to households, and last week’s jumbo-sized move was aimed at ensuring that the cut would be passed on by lenders.

Credit conditions were the decisive factor in the RBNZ’s surprise 25bp cut in July and again in this week’s decision. Since the global credit crunch began a year ago, the cost of raising funds offshore has risen significantly. Combine that with 100bp of official rate tightening in the months before the credit crunch, and the lending rates faced by households and businesses rose sharply in a short space of time. More recently, average funding costs have remained high despite a substantial fall in swap rates. The RBNZ believes that aggressive OCR cuts are needed just to offset the rise in offshore funding costs.

The RBNZ also remains fixated on the idea that the ‘effective’ mortgage rate – the average rate paid on outstanding loans – matters most. Fixed-rate loans that are coming up for renewal in coming months are likely to be fixed at rates as much as 100bp higher than before, putting further pressure on some borrowers and pushing the effective rate higher. We think this effect is being overstated. Since the start of the year there has been a sharp rise in the number of borrowers ‘fixing’ for terms as short as six months, in the hope of catching the bottom of the interest rate cycle. Rate cuts today will flow through to the average borrower much sooner than the RBNZ gives them credit for. That aside, we’d argue that the marginal cost of borrowing, not the average, is more influential – and marginal interest rates have been falling for months.

Even with the RBNZ easing harder and faster than previously signalled, they still expect consumers to be under the gun for a long time, as they are pummelled by falling house prices, higher food and energy costs, high mortgage rates and a weaker jobs market. The bleak outlook for the consumer is necessary because, to put it bluntly, the RBNZ is counting on weak growth to fix the inflation problem for them. Their view is that as consumer spending falls, excess supply will emerge in the economy, which will prevent workers from negotiating larger pay increases and businesses from passing on higher input costs.

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Published on  Fri, Sep 19 2008, 13:50 GMT