Nicola Willis issues pre-Budget warning, as high bond yields could add hundreds of millions to Govt’s borrowing costs

Nicola Willis (here with Christopher Luxon, left) warns the Government's finance costs are likely to be higher than expected. Photo / Alex Burton

Taxpayers and ratepayers are being asked to fork out more to service New Zealand’s big pile of central and local government debt.

A range of factors, including United States President Donald Trump’s tax and tariff plans, and the pandemic hangover, is seeing buyers of government debt (bonds) demand higher returns (yields) for their investments.

A side-effect of this is that it’s putting upward pressure on the returns buyers of local government and corporate sector bonds seek, as well as the interest rates banks charge those wishing to fix their mortgages for longer durations.

Both Finance Minister Nicola Willis and Treasury chief economic adviser Dominick Stephens have been flagging the situation before the Budget’s release on May 22.

“The price of borrowing has gone up. There’s no escaping that for New Zealand,” Willis told Newstalk ZB last week.

The Treasury, in its Half-Year Economic and Fiscal Update (Hyefu), said the Crown’s interest expense would be about $6 billion higher over five years if the interest rate on the Government’s stock of debt was 100 basis points higher than it forecast at the time.

Since the Treasury finalised those forecasts in late November 2024, the 10-year New Zealand Government Bond yield has risen by about 30 basis points.

At this rate, the Crown could face an interest expense about $289 million higher than expected in the year to June 2026, and $1.8b higher over the next five years.

This could see the Crown’s total interest expense surpassing the $11b mark in the year to June 2026.

ANZ senior economist Miles Workman noted these were only forecasts, and it was normal for government bond yields to fluctuate. So a lot could change in coming months and years.

He questioned why Willis was highlighting the impact of rising interest costs on the Government’s finances.

He believed that either the fiscals were going to align pretty closely with expectations at the Budget – the interest costs being one of the main variances – or more emphasis was being put on this expense than was warranted.

Workman said the big picture was that the Government issued a lot of debt during the pandemic, and this had a long-lasting legacy.

Pre-pandemic, the Treasury was issuing about $8b of government bonds per year. That figure has jumped to $40b for the current year.

Because the books are in deficit, the Government is renewing rather than repaying its Covid-era debt, all the while issuing new debt to pay for new commitments.

Stephens, in a speech delivered last month, explained the “absolute cascade” of government bonds in the market was lowering their prices and increasing their yields.

He said bond investors weren’t worried but were watching.

Demand for NZ government bonds remains very strong.

Other developed countries that spent up large in response to the pandemic face similar issues to New Zealand.

Contributing massively to the situation is the uncertainty created by Trump’s policies.

On the one hand, he’s proposing to slash spending and impose tariffs, which could weaken growth. On the other, the tariffs could be inflationary, while promised tax cuts could force the US Government to borrow more.

Workman said the net effect was that investors saw more inflation than would otherwise be the case. This was putting upward pressure on bond yields in the US. Investors were also demanding a premium to account for heightened risk.

Workman said it was hard to untangle the effects of domestic and international factors on NZ government bond yields.

He said the upward pressure the situation was putting on corporate bond yields could deter some businesses from borrowing and investing.

However, he noted a lower Official Cash Rate (OCR) could compensate for this.

The OCR directly affects floating and shorter-term interest rates.

Because those with mortgages tend to fix their loans at shorter durations, the OCR has a big effect on households’ finances, and thus their contributions to the economy.

Taking a step back, Kiwibank chief economist Jarrod Kerr said it was important to keep the government debt debate in perspective.

He noted there was a cost to under-investment. Quality borrowing and spending, particularly on infrastructure, support productivity and economic growth and ultimately boost the Government’s tax take.

Kerr believed the economy would be in a stronger position now if investment had kept up with population growth.

Indeed, many local councils are scrambling to upgrade infrastructure – their costs rising more quickly than their revenue.

The mismatch contributed towards S&P Global Ratings last week downgrading 18 councils’ credit ratings.

This will add further upward pressure to affected councils’ borrowing costs.

The policy of the Local Government Funding Agency (which councils borrow from) is to add 5 basis points to the interest rate it charges for every credit rating downgrade.

So, if a council borrowed from the LGFA at an interest rate of say 5%, this rate would rise to 5.05% in the event of their credit rating being downgraded by a notch.

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the Parliamentary press gallery. She specialises in Government and Reserve Bank policymaking, economics and banking.