Interest rates to go even higher after OCR hike

Guest post from Tony Alexander

Over the past year or so we have seen a decline in the number of properties sold in New Zealand from 100,000 down to about 68,000. The chances are that turnover will decline a bit further in coming months now that we know interest rates are still going to go slightly higher.

The Reserve Bank have just announced a record 0.75% increase in the official cash rate which now sits at 4.25%. They predict that the rate will go to 5.5% next year, that the economy will experience a 1% recession next year into 2024, and that the unemployment rate won't rise to the 5% they previously predicted but will now get as high as 5.7%.

On the face of it these developments are fairly negative for the property market

It certainly seems reasonable to talk in terms of the cycle not turning until winter next year rather than autumn given the extra upside for interest rates.

But it pays to note something important regarding monetary policy. The main monetary policy weapon is the official cash rate which rises when restraint needs to be imposed on the rate of inflation. But there is a second weapon which is the words used by the Reserve Bank and by the Reserve Bank Governor in particular.

During the last sustained monetary policy tightening cycle between 2004 and 2007 not only was the pace of increase in interest rates relatively slow but the words used were overly mild and calming. The Reserve Bank have learned their lesson. Now, interest rates are rising at the fastest pace we have ever seen and courtesy of the monetary policy statement this week the words being used are the strongest seen in a very long period of time.

This is good monetary policy because it means more people are likely to be concerned about the economy.

People will start thinking more seriously about their personal finances and employment prospects, and their personal wealth. That means the chances have just increased that consumer spending will be crunched over the next six to nine months on top of the downward impact which was going to come along anyway as a result of people rolling off previously record low fixed interest rates into rates much higher.

I still feel we are in the endgame for the housing cycle turning downward but as I have stressed from four months ago this doesn't mean house prices won't fall further. Clearly, they are going to as a result of increased household pessimism and higher debt servicing costs. But household incomes are continuing to rise courtesy of firm wages growth, job security is still very high, construction costs are going up, and net migration flows are proving to be stronger than previously anticipated.

There might be another 5% or so decline in house prices to come towards the middle of next year but there is something very important which potential buyers need to keep in mind. As each month goes by the queue of frustrated buyers gets longer and longer.

Because of the latest increase in interest rates, when the housing cycle turns upward the initial surge in activity and prices is likely to be stronger than would otherwise be the case. That means that while buyers still have time on their side there is a risk that trying to pick the bottom could lead one to missing it and then trying to make a purchase when FOMO is again rising strongly.

And perhaps there is one further thing to keep in mind

The Reserve Bank are predicting recession and rising unemployment next year. That increases the chances of a change in government in the general election. That means that as we go through 2023 more and more investors anticipating the return of interest expense deductibility are likely to look to take advantage of the high level of listings and increasingly compliant vendors to make some good long term strategic purchases.

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