Alan Clarke: Interest rates to stay down

Lower interest rates help people with mortgages.

I attended a conference in May where an impressive group of speakers from all over the world agreed that interest rates would stay low for a while. Australian economist Tim Farrelly was even brave enough to suggest that interest rates will never again get up to the 7 per cent bank rates of seven or eight years ago.

Why are rates staying down?It's all to do with the cost of borrowing. The world is still grinding its way out of the 2009 global financial crisis (GFC), so Reserve and central banks in many countries are keeping their interest rates as low as possible. This has two desirable effects:

* It lowers the cost of borrowing for companies that make goods, supply services, and employ lots of people

* Lowering interest rates helps "repel" inwards money, which tends to lower exchange rates. This in turn helps exports and also brings in tourists.

Many countries around the world have been doing this since the 2009 GFC. Many will keep their interest rates as low as possible, for as long as it takes, until their economies have recovered.

NZ has failed New Zealand has not done well in this regard. Our Reserve Bank (RBNZ) is too focused on inflation and has stubbornly kept our interest rates higher than most other comparable Western countries.

The result of the RBNZ's inflexible position is that New Zealand rates are 2-3 per cent higher than many other countries. These higher interest rates attract investors from all over the world, from Belgian dentists to Japanese housewives. The more money that flows into New Zealand, the higher our dollar rises, and the more our exporters and tourist operators are hurt in the process.

Mortgage rates

Lower interest rates help people with mortgages, but this is not the intention of Central and Reserve banks. In fact, low mortgage rates, or "cheap money", have fuelled an undesirable property boom in many major cities -- a big concern for many Reserve and central banks.

But we hear again and again that the US Federal Reserve will soon raise rates. This is quite likely, but not by much, probably only up from around 1 per cent to 2.5 per cent to 3 per cent.

The Fed is in no hurry to do so either, it wants to be really confident that the US economy has well-established and continuing growth first.

The RBNZ

The RBNZ is required to maintain inflation at between 1 per cent and 3 per cent. If our economy heats up, and inflation looks likely to go over 3 per cent, they will raise rates (the cost of borrowing) to try slow down the economy (and inflation). Of course, the reverse applies here, too. It is important to note that the RBNZ is independent of the Government in this respect.

The RBNZ is also involved in maintaining financial stability in New Zealand. It is fully aware that a bank failure in this country would be very serious indeed. This is why the RBNZ has been very vocal on the dangerously overheated Auckland property market, and has been taking some action to counteract it.

NZ trade with Australia Australia is our biggest trading partner, but its base interest rate is only 2 per cent versus our 3.5 per cent.

Accordingly, the NZ dollar is relatively high against the AU dollar. A strong NZ dollar is not good for NZ exporters as it makes our goods more expensive for Australian consumers. A high NZ dollar also makes New Zealand less attractive to Aussie tourists, and a decline in demand for New Zealand goods, services and tourism will hurt our economy.

Stop press

Wow -- recently the RBNZ took notice and hinted (it's called "jawboning") that it will gradually lower interest rates. As soon as this news came out the New Zealand dollar dropped. Thank goodness.

Income from bank deposits

None of this helps Kiwis who need income from bank deposits ... you are not on the RBNZ radar. However, there are some things you should think about, and there are some things you can do:

* You should be diversified outside the big banks since they may not be entirely safe.

* If you use your interest as income, you can't grow your money.

* For most Kiwis, bank interest as income won't be enough.

* Most of us need more money at work.

* Invest in bonds, property and shares.

* Put some of your money into a conservative-to-balanced portfolio.

* Given time, it should average 2 per cent to 3 per cent more than a bank deposit.

Alan Clarke is a financial and retirement adviser and author. His second book, The Great NZ Work, Money & Retirement Puzzle, is available at acfs.co.nz Alan is an independent authorised financial adviser (AFA) FSP26532; his disclosure statement is available on request and is free.