In my last column discussing interest rates I wrote about how the outlook is clouded for a number of reasons. It’s actually a bit worse than one might think from a predicting point of view because of two large factors suddenly coming into play.
The first is bad for borrowers and involves the US economy displaying greater strength than had been anticipated.
The good run of economic numbers has not greatly altered expectations for what the Federal Reserve will be doing with interest rates over the remainder of this year – maybe one or two further 0.25% increases. But the outlook for 2024 has changed.
All optimism that inflation would fall away quickly, and the Fed. would have to start cutting interest rates early next year if not late this year have backed off substantially. This has led to some hefty increases in US medium to long-term interest rates and that is relevant to such rates here in New Zealand as well.
The level at which the Reserve Bank sets the official cash rate – currently 5.5% - has a huge influence on the cost to banks of borrowing money in the wholesale markets to lend at a floating rate or at a fixed rate for one year. These rates haven’t changed much recently.
But for terms of two years and beyond the relevance of interest rates in the United States for the same term becomes stronger and stronger. As a result the rate rises over there have caused jumps in bank borrowing costs here which they have passed on into three more rounds of increases in fixed mortgage rates for two years and longer. This is the factor which is having an active impact in the financial markets right now.
But there is another factor in play and this one involves the world’s second largest economy – China.
All data releases in China recently have been on the very weak side. Households are reining in their spending because of wealth losses on property investments which have turned sour, plus rising unemployment.
The youth unemployment rate now sits above 21% and authorities are so concerned they have suspended publication of the numbers from now on. They have also rung around economic analysts in the country telling them not to produce negative reports on the Chinese economy.
China has huge debt which has been used to boost growth through massive investment in housing and infrastructure. But the aging, shrinking, scared population has pulled back from buying new properties, developers are failing, and prospects look bad for the next 12-18 months.
This is highly relevant to us here because one-third of our export receipts come from China and weakness there is already causing substantial declines in prices for our dairy and red meat products. It looks like the primary sector in New Zealand is going to go through a weak patch in the next 12-18 months and history tells us two things about this.
First, in the cities we do not notice this weakness for a year or so. Second, it eventually hits our overall economy with an impact exceeding people’s initial expectations. That is where we get downward pressure on interest rates set to come in our economy. But not yet.
The case is building for interest rate falls (though not necessarily large falls) over 2024 – but not this year as inflation is still much too high at 6% and businesses continue to say they intend raising their prices at twice the long-term average.
For borrowers the picture is extremely clouded.
But the implications may not be all that different from what things were looking like four months ago before these US and China shifts started appearing.
For most borrowers the incentive remains to take a mix of terms from 12 – 24 months.
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