Binging during low interest rates has caused our collective financial waistlines to bulge. Photo / NZME
Binging during low interest rates has caused our collective financial waistlines to bulge. Photo / NZME
Opinion
The Reserve Bank of New Zealand has kick-started what it expects to be a series of Official Cash Rate hikes. Unsurprisingly, the spectre of higher borrowing costs has caused quite some consternation. But concerns of a large and persistent move higher in interest rates in New Zealand are vastly overstated,writes David McLeish from Fisher Funds.
OPINION:
As I ponder my stance on the great interest rate debate, the economics lesson where I first encountered the concept of the law of diminishing marginal unity comes flooding back.
Looking on enviously, my high school economics class and I watched as our classmate consumed square after square of delicious chocolate. After each mouthful, the teacher would stop and ask the willing participant to rate the enjoyment that came from the most recently devoured piece. Their descriptions only compounded our envy.
But it wasn't long before our disappointment at not being picked for the experiment gave way to relief, as our classmate's smile turned to a frown. A few squares later and it had become a wince. Then before we knew it, they were making a beeline for the nearby bathroom.
A sugar high of monumental proportions
New Zealand households have gorged on borrowed money for years. But unlike in my class experiment, borrowed money has provided the economy with a long-lasting sugar high. That's because the economic boost from borrowing is widely estimated to be multiples of the amount borrowed. This is due to the newly created money being spent and re-spent over and over again as it circulates around the economy.
This was made possible by consistently falling interest rates. Because without dependably lower borrowing rates, households would've had to divert more of their income to servicing debt and less on spending.
As borrowing costs do a U-turn, this will almost certainly slow spending, at least once pandemic-induced distortions subside. Without another sector of the economy picking up the slack, rising borrowing costs will reduce economic growth – and with it the need to raise interest rates.
This gluttony has caused our collective financial waistlines to bulge. At around 180 per cent household debt to disposable income, New Zealand households are in worse shape to weather interest rate rises than most other households in the world.
The small rise in mortgage rates we have had so far is nothing more than the equivalent of a frown forming on my ex-classmate's face. That's because households are drawing down on the emergency funds they built up, mostly during 2020. But when these are depleted, spending will likely drop to reflect the greater cost of borrowing on households. The lofty estimates of interest rate rises that are causing all this angst will probably begin to be walked back down around this time.
Reserve Bank of New Zealand Governor Adrian Orr. Photo / Mark Mitchell
If this does evolve into a "running to the bathroom" moment, it will be because the Reserve Bank hasn't read the tea leaves right and has pushed interest too high or shifted its primary focus to something other than growth – namely inflation.
Everything is temporary, not least economist opinions
Most of us will remember the last time the Reserve Bank set out on a similar path to raise the Official Cash Rate (OCR). That was 2014 and the bank managed to raise the OCR just 1 per cent before having to change course. Today, they are projecting that the cash rate will rise by double that over the next couple of years. Their message is that this will return interest rates to some degree of normality.
I'm not sure I buy that. Household debt has risen 20 per cent compared to disposable income since 2014. The environment has changed. The economy is likely far more sensitive to interest rate changes now than ever before. Without some miraculous increase in real incomes, it feels the economy simply can't afford an interest rate rise of that magnitude.
We also can't forget that central bank opinions change easily. That's because they are based on a constantly changing world. We should therefore expect their views to change regularly and often at short notice.
Again, in March 2014, the bank's governor at the time Graeme Wheeler said "New Zealand's economic expansion has considerable momentum" and increasing the OCR was "needed to keep future average inflation near the 2 per cent target mid-point". But just over a year later, in June 2015, the bank entirely reversed course, saying instead that "a reduction in the OCR is appropriate given low inflationary pressures and the expected weakening in demand".
The message I get from that? Don't get too worked up about what central banks say about what is going to happen next year or the year after, just like my teenage views on the benefits of mass chocolate consumption, it's likely to change.
