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11 January 2023

Market Update from Tony Alexander

Tony Alexander

31 December 2022

Things then generally settled down and we could see some stepping back of buyers in the residential real estate industry. But despite increasing their interest rates, bank margins for fixed rate loans remained well below average. Then the Reserve Bank tightened monetary policy on November 23.

The Reserve Bank lifted their predicted peak for the official cash rate from 4.1% to 5.5% and warned that the economy would need to go into recession with unemployment rising from 3.3% to 5.7% in order to get inflation back towards 2%.

Their scary comments and media focus on future mortgage rate rises have been enough to encourage banks to raise their interest rates by another 0.5% or so. Now, here is where things get interesting. Margins for fixed rate lending are now roughly back at their two year averages. How can this be if monetary policy has tightened and presumably bank funding costs for fixed rate loans have jumped higher?

Actually, they haven’t. Banks have simply taken the opportunity provided by the official tightening of monetary policy via a record 0.75% rise in the official cash rate to 4.15% to finally get margins back to average levels.

Consider the one year swap rate which is the cost to banks of borrowing at a fixed rate for one year in the wholesale markets to on-lend to you and I at a fixed mortgage rate for one year. Shortly before the mid-October inflation shock this rate was near 4.8%. After the inflation outcome it jumped to almost 5.3% and banks raised their lending rates about 0.5%.

Following the 0.75% official cash rate rise on November 23 the one year swap rate settled at 5.2%. It is now actually lower than it was just after the inflation outcome. The markets had already priced in an expectation of the cash rate going to 5.5%, so confirmation of this by the Reserve Bank has not altered the wholesale borrowing costs of the banks.

Consider also the three year swap rate. It was 4.8% before the inflation number, rose to 5.15% shortly after, and now sits near 4.8%. It has fallen most recently. This reflects an expectation that monetary policy will successfully get inflation down and there will likely be rate cuts through 2024 if not before the end of 2023.

Helping to propel expectations that monetary policy will work was the ANZ Business Outlook survey for November released after the monetary policy decision. It showed a new decline in business sentiment and plans for cutting staff numbers and capital spending levels. The survey was taken almost entirely before November 23 and raises the possibility that by leaving its harshest warning words until now and its biggest one-off increase to late in the cycle, the Reserve Bank may in fact now be over-tightening monetary policy.

This would be consistent with their habit of moving too late with easing and tightening then going too far and causing things to whiplash back the other way.

What are the housing market implications?

In the short-term – as in over summer – negative. The Reserve Bank have successfully scared people with talk of recession, rising unemployment, and falling house prices. My monthly survey of real estate agents shows both first home buyers and investors have newly stepped well back from the market.

But will prices fall as far as some are newly predicting?

Probably not. Within a few weeks the discussions about interest rates are likely to start shifting from rates rising further to them not going as high as earlier expected and in fact falls becoming probable in a few months for the 3 – 5 year fixed rates. This is because we are only four months away from the predicted peak in the cash rate, forecasts of inflation and peak interest rates offshore are both falling as inflationary pressures are seen to be easing, and NZ data suggest our central bank has over-egged its pessimism.

Once buyers can see their worst case scenario for borrowing costs, some will start returning to the market assisted by rising incomes and high job security. Another supporting factor as we head into autumn looks like being better than expected migration flows.

Just as tourist numbers have so far surprised on the strong side, so too have inflows of migrants been higher than expected recently. One analyst is even predicting a net gain over 2023 of just under 40,000 people from a net loss of 8,500 in the year to October.

Worth keeping an eye on also are the political opinion polls. It is looking increasingly like there will be a change in government at next year’s general election and that means restoration of interest expense deductibility for investors.

At the same time however we need to be aware that chickens are coming home to roost in the home construction sector. As noted here and in my other writings for the past two years, too many over-optimistic, under-capitalised, inexperienced people have become property developers. They have paid too much for the land and their projects are no longer financially viable.

Already the newspapers contain stories of builders failing and home buyers losing hundreds of thousands of dollars. We are unfortunately going to see more such stories for the next 1 – 2 years as the level of house building falls back towards more sustainable levels. The good side of that however is that buyers will increasingly look to purchase an existing dwelling rather than a newly constructed one from other than the well-established larger building groups.

Disclaimer: This article is general information only. Although every effort has been made to ensure this article is accurate the contents should not be relied upon or used as a basis for entering into any products described in this article. To the extent that any information or recommendations in this article constitute financial advice, they do not take into account any person's particular financial situation or goals. We strongly recommend readers seek independent legal/financial advice prior to acting in relation to any of the matters discussed. Neither First Mortgage Trust nor Tony Alexander accepts any liability for any loss or damage whatsoever which may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this article

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