Bernard Hickey: Tightening without hiking the OCR

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

The Reserve Bank has slightly opened its forecast window for the first rate hike by a month or two in this statement. It now has the flexibility to delay the first hike to September 16 from the previous window of June 10 and July 29.

Governor Bollard has the leg room to stretch out a bit because inflation remains contained and the squeeze currently on bank lending, along with a rightly cautious bunch of consumers, is keeping the pressure off prices in the local economy.

He also has two new 'tools' which are allowing him to hold the OCR and still effectively tighten retail interest rates.

Firstly, the Core Funding Ratio introduced from April 1 and a push by the banks themselves to wean themselves off the 'hot wholesale money markets' has effectively engineered a slight tightening in actual retail interest rates, despite the flat OCR.

This will continue as the funding ratio tightens further over the next two years to 75 per cent from 65 per cent. KPMG estimates this could increase lending rates by a further 50 basis points, although the Reserve Bank thinks it will be less.

The Core Funding Ratio forces the banks to fund their lending from more stable and longer term sources such as long term bonds or local term deposits. These more stable funding methods are more expensive for the banks and they have passed on the costs in the form of higher lending rates.

Since April 30 last year, when the Reserve Bank cut the OCR to 2.5 per cent, the average 2 year fixed mortgage rate has actually risen from 6.24 per cent to 7.13 per cent, Interest.co.nz data shows. This is partly to account for the average 1 year term deposit rate having risen from 4.39 per cent to 5.05 per cent over the same period.

Secondly, borrowers are increasingly opting for floating mortgage rates, which are lower than fixed rates for the first time in a generation. Since April 30 last year the average floating mortgage rate has fallen from 6.34 per cent to 5.86 per cent.

This is known in the business (and referred to in the Governor's statement, as curve steepening. Longer term rates have risen, but shorter term rates have fallen.

This means that around 30 per cent of mortgages in New Zealand are now floating, almost double what it was at the peak of the housing boom when banks were able to keep fixed rates lower than variable rates because they could suck in cheap foreign money from the 'hot' wholesale money markets. Strangely enough, borrowers are going for the cheaper option.

KPMG estimates that around 70 per cent of new mortgages being written are now floating.

This is why the Reserve Bank now feels confident that it can wait a teeny bit longer. It believes that when it does hike the effect on the economy will be more immediate and it won't have to raise the rate as high as in the future. Fair enough.

It is good that the Reserve Bank has these extra powers, both directly through the Core Funding Ratio and indirectly through the curve steepening.

But I still think the Reserve Bank should have hiked today or should at least have stuck to its previous time-table of a 'middle of 2010' hike.

The Reserve Bank of Australia has already hiked 5 times since October last year and is widely expected to hike for a sixth time to 4.5 per cent next week.

It is experiencing the biggest mining boom in over a century and it is our biggest trading partner. The New Zealand dollar has fallen sharply against the Australian dollar, boosting returns for exporters to Australia and encouraging droves of tourists to come here. Commodity prices are at record highs.

China is also tightening to slow its economy from a break-neck pace of 11.9 per cent growth in the first quarter. It is also cracking down on a credit-fuelled real estate bubble that is spilling over the sides into the Canadian, the Australian and Auckland markets. China is now our second biggest buyer of exports after Australia.

Consumer spending in New Zealand, particularly with credit cards, is picking up again and business confidence surveys are signalling GDP growth of 4-5 per cent in the year ahead. Leaving interest rates at 2.5 per cent seems a tad risky with that sort of growth outlook.

INTEREST.CO.NZ