Go slow on interest rate rises

“The Reserve Bank should be very cautious about any increase in interest rates when considering its Official Cash Rate announcement on Thursday,” says CTU Economist Bill Rosenberg. “For many households, especially those on floating rate mortgages, it will go straight into higher housing costs. There is pressure from financial markets to raise the rate by at least 1 percentage point (from 2.5% to 3.5%) by the end of the year and a further percentage point (to 4.5%) by the end of 2015.”

Each percentage point rise costs a family $20 per week for each $100,000 of their mortgage. So a family with a $300,000 mortgage could face $60 a week in extra costs by the end of the year, and $120 per week by the end of 2015.

“For families still struggling after several years of income increases barely meeting other price rises, and many going without pay rises year after year, this is a large additional cost to face”, Rosenberg says.

“In addition, some businesses looking to borrow to fund expansion, will have to consider whether they can meet higher borrowing costs. That could reduce job growth and improvements in productivity.”

“While the economy as a whole is recording strong GDP growth, remove the boost from the Canterbury rebuild and the growth looks very modest. Unemployment is still at 6.0% with 147,000 people unemployed, 257,100 jobless, and 122,600 part time workers wanting to work more hours. Wage growth is still very slow.”

Inflation is still low – at 1.6% in the last year, but 1.5% outside Canterbury where it was 2.4% in 2013. The biggest contributions to the increase were increased taxes on cigarettes and tobacco, housing, including rents, home ownership and energy. Insurance costs are also rising, as are some government-related charges such as for medicines, and tertiary education fees. “These do not look like a general increase in price levels and are better addressed directly rather than hurting living standards and job growth through cross-the-board interest rate rises,” Rosenberg says.

He says there is also a risk to the exchange rate and New Zealand’s international indebtedness if interest rates rise faster here than in other countries where they are mainly still very low with rises months or years off. “Rising interest rates, with the difference between New Zealand and the rest of the world growing, will attract an influx of money, raising the exchange rate and hurting exporters. It will encourage banks to use overseas borrowing to fund mortgages, raising overseas indebtedness – and making the Reserve Bank’s actions less effective.”

“If the bank sees house price inflation as the main danger, it should address that directly. It has started to do that by restricting how much people can borrow towards a house (Loan to Value Ratios), but has aimed that mainly at financial sector stability, not at house price stability. It could use other policies such as raising bank capital requirements for housing loans, tightening core funding ratios, or more directly restricting use of overseas funds. Any of these must be accompanied by much stronger government action to ensure they don’t end up hurting those who need good housing the most – such as first home buyers and people needing to rent good quality low cost houses”, said Rosenberg.

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