NZ interest rate lows are in the past, now what?
With the RBNZ starting to hike rates, what will be the flow-on effect on homeowners and property investors?
New Zealand’s economy has shown strong fundamentals to support the Reserve Bank of New Zealand’s (RBNZ) decision on 06 October 2021 to increase the Official Cash Rate (OCR) by 25 bps to 0.50%. This is the first increase in the OCR in seven years. Key evidence of the economy’s growth was the strong surprise on the upside of 2Q21 GDP at 2.8% together with unemployment running at 10-year lows of 4.0%. The most recent CPI release for 3Q21 of 4.9%, being well above RBNZ’s policy target for inflation of 1.0% to 3.0%, supports the firming of interest rates.
Currently, there is a consensus amongst most commentators from the RBNZ, market pricing, and the average of major banks as to the timing and the level the OCR will increase to by late 2023. A rise in interest rates will play an important role, enabling the RBNZ to manage inflation back within its policy targets.
Figure 1: NZ Forecasts for OCR and CPI
Source: RBNZ MPS, JLL
For commercial property borrowers, unless you have fixed rates then your borrowing costs will increase, which many are already experiencing. It is not uncommon for borrowers to have an Interest Cover Ratio (ICR) covenant, which shows the banks the borrower can meet interest payments comfortably. Good operators will positively manage income and costs, including rental income, non-recoverable OPEX, abatements, vacancies, and management fees, as many of these will be factored into ICR calculations.
Increasing interest rates for the homeowner will impact mortgage repayments, resulting in a larger portion of mortgage repayments covering interest costs rather than reducing the principal amount. Many New Zealanders with mortgages will feel the impact, if not now then shortly.
As of 31 August, 27.4% (NZD88.4 billion) of mortgages are floating or fixed for less than three months, with a further 46.9% (NZD151.2 billion) maturing within the next 3-12 months. That’s NZD239.6 billion floating or maturing within 12 months, and with a 0.50% increase in rates on this funding from current levels will add over NZD1.0 billion in interest costs annually. As homeowners reset their mortgages on higher rates, they typically reduce their discretionary spending as they look to tighten their belts.
Figure 2: NZ Mtgs Fixed vs Floating (as a %)
Source: RBNZ, JLL
Remember, one of the best mitigants against rising interest costs is to reduce funding levels where possible.
Rising mortgage interest rates, together with the recent confirmation of tightening of LVRs, are few measures RBNZ is taking to manage house prices to a more sustainable level.
RBNZ took its first steps back in July 2021 to normalise monetary settings from emergency levels by halting Large Scale Asset Purchases. The second step is to increase interest rates as it manages the NZ economy’s strong medium-term outlook and rising inflation.