Households and banks will be ‘challenged’ by rising interest rates and cost of living, the Reserve Bank warns

Households have borrowed heavily. Governments’ debts, too, are at new highs. Financial markets are volatile. These are unprecedented economic times, the Reserve Bank says.

“Historical experience provides little indication as to the economic impact of the current tightening cycle, particularly given the public and private debt burdens that have built up.”

Global supply chain disruptions, ongoing food and energy supply shocks, scarce labour resources, and the lagged effects of fiscal and monetary policy have all contributed to high inflation. Bank Governor Adrian Orr has discussed how fiscal and monetary policy can respond to soaring inflation – beyond just hiking interest rates up and up and up.

Already, he says the rising global rates will test New Zealand’s financial resilience. Releasing the central bank’s biannual Financial Stability Report, he says some households and businesses will be challenged. “It is important that financial institutions take a long-term view when supporting customers and allocating credit to the wider economy.”

“The sooner you talk to your bank, the more likely they’ll be able to help.”
– Roger Beaumont, Bankers’ Association

The report says a severe downturn in any of New Zealand’s major trading partners would lead to reduced demand for our exports, in turn lowering incomes of households and businesses, and leading to losses on banks’ lending. 

“New Zealand’s financial system is well placed to support the economy in the face of a rising interest rate environment,” the report says. “Banks’ capital and liquidity positions are strong, and profitability and asset quality remain high. Recent stress tests demonstrate banks’ resilience to scenarios involving rising unemployment and interest rates, and declining house prices.”

Two-year wholesale interest rates (swap rate, weekly average). Sources: Reserve Bank / Reuters

Already, about 2 percent of mortgaged homeowners are in negative equity, and as house prices fall further from last year’s peak, that’s expected to rise. If house prices drop 30 percent, then nearly two-fifths of borrowing will plunge into negative equity.

And at an interest rate of 7 percent, the Reserve Bank says about 46 percent of 2021’s mortgage borrowers would need to spend at least half of their after-tax income on interest payments.

Negative equity among borrowers does not in itself lead to losses in the financial system. However, the default of a borrower who is in negative equity means the lender may not be able to recover the full value of their lending, for example through a mortgagee sale.

Among households with mortgages, the average percentage of disposable income dedicated to debt servicing is expected to rise from a recent low of 9 percent to 20 percent – a fifth of their after-tax disposable income. 

“If the labour market slows too fast, then the housing market would experience an even sharper correction.”
– Jarrod Kerr, Kiwibank

“The number of households in financial difficulty will grow as more fixed-rate mortgages reprice, and could increase significantly if mortgage rates rise materially above the servicing assessment rates of around 6 percent that banks applied through the pandemic period,” the report says.

“The labour market continues to perform strongly, but a significant deterioration in labour market conditions would lead to household debt servicing stress. In these situations, lenders are likely to be able to provide relief in the form of term extensions or temporary interest-only periods for households unable to fully absorb the repayment increases they may be facing.”

“It is important institutions take a long-term perspective in the face of the current economic uncertainties, making prudent lending decisions and providing ongoing access to credit for the wider economy, as well as supporting customers in stress.”

New Zealand house prices (seasonally adjusted, indexed to peak values). Source: REINZ / Reserve Bank

Bankers’ Association chief executive Roger Beaumont says the country’s banks are very conscious of the impact current economic conditions will have on many New Zealanders. Anyone experiencing financial difficulty should contact their bank to discuss their options. “The sooner you talk to your bank, the more likely they’ll be able to help.”

He says options could include lengthening the term of the loan, or reducing the amount of regular repayments. In some cases, temporarily moving to interest-only repayments may also be an option.

“Banks are responsible lenders and when assessing a loan application they apply higher ‘serviceability’ rates to see if you could still repay the loan if interest rates go up. So typically there’s a buffer already built in for borrowers.”

The latest figures show nearly 46 percent of people with a home loan are ahead on repayments, which will help insulate them. That’s because, as interest rates declined over recent years, they likely retained their repayments at the same level, or increased them, to help repay their loans faster. Beaumont says that shows a good level of financial capability. Similarly with credit cards, around two-thirds of card holders pay off their balance without incurring any interest costs.

Jarrod Kerr, chief economist for Kiwibank, says the Reserve Bank is walking a tightrope. The unemployment rate is set to lift from the record low of 3.3 percent, reported today by Statistics NZ, back toward the long-run average of around 4.5 percent by 2024.

“Spending is slowing in the face of rapidly rising interest rates and falling house prices, which should sap firms’ demand for workers,” he says. “In addition, we see net migration becoming a smaller drag on growth in the labour force, as cross border flows return to more normal patterns. We deem such an outcome as a controlled cooling in the jobs market.

“There is no room for relenting on the path to higher interest rates yet.”
 – Michael Gordon, Westpac

“If capacity is not returned to the labour market, wage inflation would be expected to peak higher, and forcing firms to pass on more cost increase onto consumers. If the labour market slows too fast, then the housing market would experience an even sharper correction.”

Westpac’s acting chief economist, Michael Gordon, says the Reserve Bank was already braced for some strong wage outcomes, so this week’s unemployment figures don’t necessarily increase the risk of a large interest rate hike at the next monetary policy review, later this month.

“However, they do highlight the extent of the challenge that the RBNZ faces in bringing inflation pressures under control – there is no room for relenting on the path to higher interest rates yet.”

At ANZ, economists Finn Robinson and Miles Workman read the continuing high employment as helpful to those managing household budgets. “The good news for financially stretched households is that average wage growth is now comfortably exceeding annual consumers price index inflation, with private sector average hourly earnings rising 8.6 percent year on year.”

Newsroom Pro managing editor Jonathan Milne covers business, politics and the economy.

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