I see that many people with mortgages and the real estate industry are already celebrating Wednesday’s announcement of the 0.5 percentage point drop in the official cash rate (OCR). The OCR is now just 1%. The lowest on record.
Before all of you who are celebrating this move get too excited, I’d like to express some of my concerns.
An under performing economy
The OCR is controlled by the reserve bank and they use the rate as a tool to control where people spend their money.
Basically, if people are spending too much money and inflation is too high, the reserve bank will increase the OCR to encourage people to save.
If people are spending too little and inflation is too low, as it is now, the reserve bank will lower the OCR to encourage people to spend.
The fact that we are being encouraged to spend is not a good thing. It means that our economy is not ticking along as well as it could be, and that the economy is slowing down.
Not only is our economy slowing down, but there are also huge international risks at this moment. There are significant problems in Hong Kong, Kashmir, and the trade war between USA and China. Not to mention the uncertainty of Brexit.
Interest rates aren’t this low because the economy is booming. It is under performing and the outlook is worsening. All we need is one or two of these international disasters to worsen and our economy will be dragged down with it.
Not much wriggle room
During a recession, our Reserve Bank historically has room to reduce interest rates significantly to encourage spending. If we experience a recession in the near term, the reserve bank has very little room to decrease rates. Only 1% in fact.
For perspective, the Reserve Bank decreased the cash rate from 8.25% to 2.5% during the 2008 to 2009 recession. Link here. Less than one year and the rate was dropped 5.75 percentage points. Now we only have room for a 1 point drop!
What this means is that the Reserve Bank will only have a very limited impact on resurrecting the economy. The stimulus may have to come from an increase in spending from the government, while borrowing is cheap.
The Reserve Bank has stated that negative interest rates are on their radar. That’s right. We may have to pay to leave our money in the bank.
I don’t think the 0.5 percentage point drop in OCR will encourage everyone to spend like the Reserve Bank is hoping for. I think the people of New Zealand actually don’t have the high disposable incomes in order for them to spend.
Even the ones that could, they realise that the low OCR is not a good sign for the economy and they are likely to squirrel their money away to help protect them from any impending recession.
Businesses are cautious of the current environment and a less than 0.5% drop in borrowing rates won’t change that confidence, or lack thereof.
Overvalued stocks (and other investments)
In periods of lower interest rates, people that would typically put have their money in the bank start looking for other investments, such as property, stocks, and gold, in the hope for higher returns. There are two problems with this:
1/. If they wanted to be in these investments already, they would be. By only investing in these asset classes because the bank returns are poor, is not a good reason to invest and is taking on more risk than they wanted.
2/. A lot of asset classes, in particular property and stocks, are already very highly priced. By more people moving their money from banks to these investments, it will only add further fire to the already overheated prices. People are no longer investing in these assets on their merit/value, but only because there is no other alternative. This means overpricing these assets and pushing them further into bubble territory and the bigger the bubble gets, the bigger the pop.
Return on savings
The Reserve Bank obviously don’t care about savers in a low inflationary environment. Their job is to keep the economy humming and bringing in 1-3% extra spending each year, with a focus on the 2% mid point.
If at least 2% inflation isn’t occurring, or predicted to occur, savers suffer.
We are encouraged to go out and spend via lower interest rates.
On the flip side however, if inflation was higher than the 1 – 3% target, we would likely see higher returns for savers.
This may see less people leaving money in the banks, which is one of the reasons why the Reserve Bank have all of a sudden become strict on enforcing lending standards and asking the banks to have sufficient reserves.
Houses are still not cheap
You will start hearing from the media and those in the mortgage and real estate industry how cheap borrowing for a house has become.
This will in turn send more people to taking out mortgages and buying houses.
Well, houses are still not cheap. They are extremely unaffordable by any standard.
And remember the price you pay for your house is fixed. Interest rates are not. Sure, low interest rates may help in the short term, but when, not if, interest rates rise again, we will start to see a lot more people under mortgage stress with increasing interest rates and decreasing house prices.
That could well lead to an influx of mortgage defaults and foreclosures, sending the economy further into the crapper.
Message to go and spend
I’m not sure spending more is the right message when New Zealanders are not saving enough as it is. In fact we aren’t saving at all. The average is -1.4%
Encouraging more people to go in to debt will not turn out well. All it is doing is kicking the massive debt filled can further down the road. Eventually the can will stop and many of us will be caught short.
Encouraging people to spend and borrow in an economy with a poor outlook, and when we are already in high amounts of debt, can’t end well.
I feel like the Reserve Bank has moved too much and too soon, effectively delaying the inevitable and backing themselves closer to the corner.
Eventually we need to repay our debts. We can’t keep pushing this out or the fall from grace will be significant.
Particularly emphasised by the fact that we are already so close to negative interest rates during a period of low unemployment and no overseas triggers for a recession. Yet.
It feels to me there is a lot of uncertainty and tension worldwide, and it is only matter of time before the trigger for the next recession is ignited.
Homeowners may be feeling rich with the recent cuts in interest rates, but don’t get too excited. Low rates means a faltering economy.
We should be buckling down while times are good and doing everything we can to protect ourselves from losing too much money.
This is a good time to do some financial planning. Ensure you have appropriate insurance cover, and that your asset allocation is not beyond your risk tolerance.
Now, more than ever, it’s important to be diversified, have clear goals, know what you are invested in, the pros and cons of each type of investment, and understand how much risk you are truly willing to take on.
The Reserve Bank, with Wednesdays announcement, obviously have grave concerns about the outlook of the economy. Take heed of their unsaid warning (gloomy forecasts), but not their message (spend more). Spending and borrowing too much will only dig a deeper hole that will be difficult to get out of when crap hits the fan.
But hey, what do I know. I don’t get paid a bunch and work for the RBNZ.
Just like you, I don’t have a crystal ball. These are only one man’s thoughts on how I am approaching things.
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