Interest Rates

Wednesday 08 October, 2008

After rising last week in response to some better than expected economic data, the events offshore have encouraged increased expectations of easing monetary policy in New Zealand so wholesale borrowing costs have fallen in some instances. Or at least the wholesale borrowing costs we can see in the form of bank bill yields and swap rates have declined. What we can't see is what has been happening with the risk premium we banks have to pay in order to borrow bulk quantities of funds offshore. Such borrowing is sporadic and we don't have an update as yet. But it would seem fair to conclude in light of interbank borrowing costs offshore rising by record amounts that if a New Zealand bank did have to borrow a decent quantity of funds offshore at the moment the risk premium to be paid would probably be well above the 2.2% paid by one local operator two or three months ago.

This afternoon the yield on 90 day bank bills has ended close to 8.05% from 8.1% last week. The two-year swap rate has ended back down near 6.9% from 7.06% last week. The next review of monetary policy comes on October 23 and we expect the cash rate to be cut 0.5% to 7.0%.

Key Forecasts

• Monetary policy easing with the official cash rate near 6% come late 2009.
• The two year fixed housing rate falling below 8.50% at a stretch late 2008, hitting the five year average of 7.8% in mid-2009 optimistically, but going lower will require weaker data on the NZ economy and decent easing of global credit tensions – possible late in 2009. Falling to the 6.5% low of 1999, 2001 and 2003 is very unlikely this cycle.

If I Were a Borrower What Would I Do?

As the Reserve Bank Governor pointed out during the week there is a difference between reacting to a crisis in the international credit markets by easing liquidity conditions and altering the official cash rate which is geared more towards affecting inflation outcomes 18 months down the track. In other words he was perhaps giving a warning not to expect massive cuts in our cash rate of appearing in the near future just because the situation offshore has become worse.

Nevertheless, given a reasonable expectation of some decent cuts in the cash rate soon, if I were borrowing at the moment I would remain extremely reluctant to fix for any period longer than one year. I would probably toss a coin between fixing six months and fixing 12 months though will at some point feel it is best simply to go floating. Personally speaking I don't think we are quite at that point yet.

Source: Tony Alexander, Chief Economist of the Bank of New Zealand.