18-month recovery was 'unrealistic'

WELL, the "big unknown" kicked in over the past week with offshore developments dominating the news and affecting our medium to longer term fixed interest rates.
The Reserve Bank has reasonable control over our shorter term financial markets through Official Cash Rate (OCR), but hanging over the longer term markets are developments overseas beyond New Zealand's control.
There has been continued worldwide concern over the Eurozone economies and less positive economic data out of United States.
Financial markets are questioning whether some economies are actually going to make it out of recession in the near future, and also just how long the recovery process will take.
Some commentators are now starting to say: "18 months to come out of the world's worst financial crisis for 75 years was unrealistic."
At this stage, it looks like we, being the global economy in this case, are in for a longer haul than hoped.
On the local front, the news is a lot more positive as New Zealand is far better placed than most countries. The strong economic fundamentals the Reserve Bank assessed when it recently increased the OCR are still relatively unchanged - as are the prospects for our major export markets.
It would therefore seem reasonable that the Bank will continue the tightening process with another 0.25 per cent increase on July 29, but may pause and assess after that. The next review is due September 16.
Our medium to long term fixed rates were affected by interest rates dropping overseas due to markets taking a far more negative view about growth prospects.
The flow-on from that is that markets expect interest rates to be held lower for longer, and combined with reasonable liquidity (plenty of money currently available) meant the price for money reduced.
In New Zealand we saw, very unexpectedly, banks being able to reduce their 2 to 5-year fixed rates, and quite substantially at the longest end. We now expect to see a flattening of the yield curve, meaning the shorter term rates may increase as the OCR rises - and they may get closer to the medium and longer term fixed rates.
As always, there is a lot of uncertainty around this and the medium to longer term fixed rates will be driven by offshore sentiment and rates.
With this much uncertainty, I believe it reinforces a strategy of taking a mix of rates.
I still favour the 1-year rate over the variable, and a mix of the 18-month and two-year rates.
We need to observe what happens to markets and rates offshore in the next week as that may also bring the three-year rate into play. That is starting to show reasonable value when compared to the five-year average.
Brian Berry is a director of Rothbury Financial Services, based in Tauranga. He can be contacted on: phone 0800 33 34 35, fax 07-5790666 or email brian@rothbury.net.nz