Bernard Hickey: Low rates not always best

Reserve Bank Governor Dr Alan Bollard. Photo / Mark Mitchell

The country appeared to breathe a collective sigh of relief this week when Reserve Bank Governor Alan Bollard cut the Official Cash Rate by 0.5 per cent to a record low 2.5 per cent. His view that it was a necessary confidence boost for an economy on its knees was widely accepted. But here's five reasons why very low interest rates here and overseas are not good.

They punish savers

Headline writers and interest groups almost always see the world through the prism of the borrower. Either they are in debt themselves or believe the "mortgage belt" is the dominant political and consumer force. New Zealand households owe $183 billion, farmers owe $47.8 billion and businesses owe $73.3 billion. Yet households have also put $97.4 billion into deposit accounts at banks.

Bollard has previously commented he gets the most complaints when he cuts interest rates as retirees and others who depend on deposits see their income slashed. This week's decision is likely to cost anyone with $200,000 on deposit at a bank about $20 a week before tax.

They encourage borrowing

Our net foreign debt is approaching 90 per cent of GDP, which is similar to the PIGS (Portugal, Ireland, Greece and Spain). Most of this is private mortgage debt owed via our banks to foreign creditors. Lower interest rates just encourage New Zealanders to borrow more.

They encourage risk taking

A side effect of the extremely low interest rates imposed by the US Federal Reserve and other central banks is that it encourages banks and others into riskier assets.

Many investors in America who are reluctant to accept nearly zero per cent from term deposits are pushing their money into corporate bonds, emerging market bonds and higher-yielding shares.

This is exactly what the US Federal Reserve wants, hoping it will trickle down into investment in businesses and jobs.

Unfortunately most of the freshly printed US dollars are being pumped into higher commodity prices and investment in developing economies such as China and India. Some of this almost free money is also finding its way to New Zealand.

Ironically one of New Zealand's biggest foreign borrowers at the moment is Kiwibank, which has borrowed hundreds of millions offshore in recent months because it is easier and cheaper to get than term deposits locally.

Also, companies including Auckland International Airport, Mighty River Power, Transpower and Vector are planning to borrow at least $1 billion on the US private debt market this year.

They lower lending standards

Lower interest rates encourage those who can't afford to pay higher rates to borrow.

Lower rates are often accompanied by a lowering of credit standards by banks.

The biggest banks have been offering 95 per cent loans through brokers in recent weeks, boasting of how many deals they have done and encouraging borrowers to increase the size of their loans to renovate and extend.

They blow up asset bubbles

The events of the past decade should teach anyone that low interest rates eventually blow up asset prices into bubbles that burst. The biggest cause of the sub-prime crisis in America was the slashing of interest rates after the September 11 terrorist attacks.