Interest rate increases are a slow-acting poison dart in that the true impact isn’t felt immediately. It’s only when the poison truly kicks in that we start to feel the potency of what’s been administered.
So far most New Zealanders have been protected from the effect of rising interest rates by fixed-term mortgage rates locked in during years of record lows.
But that immunity is set to run out in the coming year.
Westpac senior economist Satish Ranchhod says that close to half of all fixed-term mortgages will come up for repricing over the next 12 months. In many cases, those borrowers will face refixing at substantially higher interest rates.
Borrowers who fixed for two years in 2020 may have secured a rate in the 2.5 per cent to 3 per cent range. Those same borrowers are now looking at a two-year rate that’s more than 3 percentage points above what it was back then.
This will take a huge bite out of disposable incomes available to New Zealanders.
Ranchhood offers the example of a family who purchased an average-priced house in 2020 and took an 80 per cent mortgage fixed for two years. Compared to what they were paying in 2020, their minimum fortnightly payments are set to rise by around $470 if the mortgage was refixed today. And it’s even worse if you live in Auckland, where the increase in debt servicing costs will be around $800 per fortnight.
This means borrowers will have to spend around 12 per cent more of their disposable income just to meet the minimum repayments - which translates to the median household spending 40 per cent of their fortnightly income on debt servicing (up from 28 per cent in 2020). Forget any hopes of even getting ahead of your payments. This is the bare-bones minimum we’re talking about here.
What’s more is that the Reserve Bank isn’t done, with Westpac forecasting another 50 basis point hike in February and another 50 basis point rise in April. Those increases would take the cash rate to 5.25 per cent, its highest level since 2008. Incomes have increased sharply over the last year, with average hourly earnings up by 7.4 per cent. But the impact of this mortgage shock will all but eliminate those gains.
Ranchhod didn’t mince his words, saying the economic pressure will shift from “a squeeze to a crush”.
This will reverberate throughout the economy in the coming year. When you take $1600 of disposable income away from a family per month that gives them less to spend on other items that they need or want – which means businesses will also feel the pinch.
The impact of this will not be felt equally across society, according to ANZ chief economist Sharon Zollner.
“The household debt servicing burden – the proportion of household income being spent on mortgages – troughed at around 5 per cent and it’s heading upwards. On our forecasts, it’ll go to around 11 per cent in a year or two. So it’s more than doubling,” she said in a recent interview on The Front Page podcast.
This is still lower than the 16 per cent we saw in 2008, but recent house buyers – or those with large mortgages – will suffer the biggest blows when this comes to fruition. These people are the collateral damage that comes from the Reserve Bank using the blunt instrument of raising interest rates to take the heat out of the economy.
“The Reserve Bank sets policy for that mythical median household, and they’re still doing okay,” Zollner explains.
“The challenge for young people is that they’re the minority. There’s nothing fair about the way monetary policy operates. It doesn’t affect people evenly at all. In fact, we often forget about the savers who are quite happy to see deposit rates going up.”
Because New Zealanders have continued spending and the economy has continued to run so hot, the Reserve Bank has kept nudging those interest rates upwards, Zollner says.
“[Reserve Bank Governor] Adrian Orr has issued a pretty open threat that if people don’t start changing their behaviour, then interest rates are going to go even higher.”
“Now, you’re seeing in business confidence surveys that expectations are incredibly widespread of a recession this year. And that’s perfectly logical when you’ve got the central bank governor saying he is deliberately engineering one and he can in theory take interest rates to the moon.”
The fundamental problem in all this is that for the Reserve Bank to pursue its mandate of bringing inflation into that target rate of between zero to 2 per cent, it will have to keep crushing these more vulnerable Kiwis before the impact hits the mythical median household.
Infometrics principal economist Brad Olsen says that this means the coming hard times will feel particularly tough for those younger Kiwis who bought into the promise of the booming housing market.
“It makes the Reserve Bank’s job even harder because it means that those households, particularly the younger ones, are getting hit harder as the Reserve Bank tries to reign in the economy,” says Olsen.
“So far the interest rate hikes that have come through have affected a much smaller group in a much more concentrated way. And so the risk, of course, is that if the Reserve bank wants to get even further traction with the wider New Zealand economy, it does have to go a little bit harder before it really captures a wider group of households that aren’t just those who bought in the last three years.”
Over the past year, New Zealanders have been able to negotiate their way through the record-high inflation of 7.2 per cent by negotiating pay rises or switching to other roles. But this strategy isn’t likely to work in 2023.
Jobs are down, employment intentions are down and most business surveys suggest firms are tightening their belts, says Zollner.
“The Reserve Bank’s forecast has built-in unemployment rising from the first three months of this year almost as quickly as it did in the Global Financial Crisis,” the economist explains.
“Thankfully, this doesn’t feel like the GFC, but there is now a risk that things aren’t going to loosen up quite as quickly as the Reserve Bank is expecting. But, it’s worth remembering that typically we find out the economy’s going through a recession when we’re halfway through it.”
This time things are a bit different because the recession is being intentionally engineered in an attempt to get on top of inflation.
Not everyone is convinced that raising interest rates is the answer to solving the inflation problem.
“The combination of recession and rising real interest rates is very dangerous,” Harvard professor Ken Rogoff told The Telegraph this week.
Rogoff, the former chief economist at the International Monetary Fund, said that continuing to push up rates increases the likelihood of triggering major financial distress as the delayed effects feed through. Rogoff says the world was fortunate we didn’t have a global event in 2022, but the risk keeps rising as rates go up.
“This could pop anywhere,” he said. “Global debt has gone up massively since the pandemic: public debt, corporate debt, everything.”
He argues that those optimistic about this recession having a soft landing often underestimate the potency of the delayed impact that comes with monetary tightening.
So as the Reserve Bank continues to fire poison darts into the New Zealand economy, we trudge on not realising how difficult our steps down the road might become.