Sudden surge 'bad news' for real rebound

ANZ National Bank chief economist Cameron Bagrie

The sudden surge in interest rates and the dollar is the last thing the economy needs and could push back its eventual recovery, economists warn.

Perversely, a scramble by borrowers to lock in lower mortgage interest rates has driven both wholesale and retail rates sharply higher, especially three-to five-year loans.

At the same time the kiwi dollar has climbed, by some 5 per cent on a trade-weighted basis in the past two weeks.

Just three weeks since the Reserve Bank signalled it intends to cut the official cash rate further by 50 or at a pinch 100 basis points and that it expects the exchange rate to fall, the swaps market is discounting any further easing and has priced in the Reserve Bank tightening again by the end of the year.

ANZ National Bank chief economist Cameron Bagrie said the tightening in monetary conditions was coming when the economy was still very weak and created headwinds for the rebound which the Reserve Bank expects in the second half of this year.

People's desire to beat the market had shifted into overdrive, he said.

Higher interest rates encouraged them to fix for fear of missing the boat, putting upward pressure on the wholesale curve and fixed lending rates, and setting the spiral in motion.

While there was some anecdotal evidence of recovery in the housing market, the combination of rising interest rates and falling job security would quickly snuff that out, he said.

Indeed Bagrie suspects the "frenzy" that has developed is a symptom of mounting stress on households.

"Few households will have the stomach to stand by and watch fixed rates move higher especially if they have been on the right side of the market - i.e. floating - as rates have fallen."

Bank of New Zealand economist Craig Ebert said overdone expectations of a recovery were stifling chances of a rebound actually occurring this year.

The Reserve Bank, which has eased policy in a bid to stimulate the economy, would not be happy with the de facto tightening which had occurred.

The question for the next official cash rate review on April 30 was whether the bank would cut by 25 or 50 basis points, he said. BNZ is in the 50 points camp.

Ebert expects some vigorous jawboning from the central bank. "They need to be quite clear that there is still a good chance that they will cut further and that rates are likely to stay low for a long period, which will talk down the curve," he said.

"The irony is that the ramp-up in interest rates and the currency increases the likelihood that the bank will cut by 50."

It also had the option of intervening in the foreign exchange market and selling the kiwi dollar.

Ebert does not see the recent market action as a symptom of a broader turning point in sentiment about the New Zealand economy. "This is just happening because people want to rejig their debt."

But the rally on New York equity markets may have buoyed sentiment.

"People have got to get real. They say it is all about confidence and if only we could regain our confidence we will be fine. But will that get rid of the massive toxic debt problem around the world all of a sudden? Or the problems of firms having to manage plunging profits?"

Ebert expects a roller-coaster of misplaced optimism followed by bouts of renewed resignation.

Westpac chief economist Brendan O'Donovan said there was no urgency for borrowers to fix for longer periods.

"Short-term rates are significantly lower than long-term rates and we don't expect them to rise any time soon as the Reserve Bank is likely to be disappointed in its hopes for a strong rebound in the second half of this year," he said.

"The trade-off between fixed and floating rates is likely to be much the same in three or six months' time as it is today."