The official cash rate is either going to stay where it is for a long time or a very long time, according to Fergus McDonald, head of fixed interest and currency at Nikko Asset Management New Zealand.
If the OCR does move in the short term, something he thinks is unlikely, it will be down. Otherwise, the next move is likely to be up – a long way down the track, McDonald told an investment conference in Wellington on Monday which was organised by Nikko.
The OCR currently sits at 1.75 percent, its record low, and has been there since November 2016.
One reason for the OCR to stay low for longer is the outlook for tourism numbers and the terrorist attack in Christchurch on March 15 “may take some gloss off inbound tourism,” he said.
“Having New Zealand rates low and stable is a good thing for the economy but not necessarily for fund managers.”
Such low rates and the relatively stable exchange rate will support the New Zealand economy, underpin employment and encourage businesses to invest and are good policy settings.
The currency has traded between 64.26 US cents and 74 cents in the past 12 months and between 64.26 cents and 69.45 cents in the past six months.
The fact that New Zealand’s longer-term interest rates have been below those in the United States for about 18 months reflects that the Federal Reserve has been raising rates while New Zealand’s OCR has been unchanged, McDonald says.
Local longer-term rates will only return to trading at a premium to US rates when monetary policy in both countries becomes aligned again, he says.
It will be “a little bit of wait and see” whether the Reserve Bank’s proposed near doubling of the minimum amount of capital banks have to hold will translate into higher lending rates on mortgages and corporate finance.
But the current return on equity of 10.5 percent to 15 percent for the big four Australian-owned banks is “probably on the high side.”
The Reserve Bank wants the big four banks to increase their tier 1 capital from 8.5 percent to 16 percent over a five-year phase-in period and is currently consulting on this but McDonald thinks the change will happen.
“Responses from the banks will be multi-pronged. One is they will accept a lower return on capital.” They will also look for efficiency gains including more branch closures, greater use of technology and fewer staff, and they will want to increase their lending margins.
Some commentators “are perhaps over-stating the widening of margins,” McDonald says.
While the Reserve Bank has estimated a 20-40 basis point increase in bank margins, UBS has said it will be more like 86-122 basis points which would add as much as $6,100 a year to the interest bill on a $500,000 mortgage.
McDonald says the major banks are unlikely to cease lending in New Zealand.
“The banks make money by lending to people. They don’t make money by sitting on vast swathes of cash.”
The Reserve bank is also keen to see a more vibrant market in mortgage-backed securities, McDonald says.
But if bank margins do expand further than he expects, the Reserve Bank will react by easing the OCR.
Yields on US three-month Treasury bills are now trading above those on 10-year Treasury bonds, traditionally a sign of a looming recession.
If that turns out to be a signpost to a global slowdown, “that’s another reason why the Reserve Bank may cut interest rates,” McDonald says.
But barring that or a major natural disaster, “everything says to me that the settings are about right.”
The economy is still growing, even though that growth has slowed, and inflation is still below the Reserve Bank’s 2 percent target. So there’s no reason to raise rates but equally there’s no reason to stimulate the economy further, McDonald says.