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W & K

Are Interest Rates Artificially Low?

21 Jun 2017

Most central banks around the world, such as the New Zealand Reserve Bank (RBNZ), manage key interest rates as a means of controlling inflation. The RBNZ was one of the first to do so in 1989. Their mandates are typically to keep inflation under control and to keep employment full. In New Zealand’s case, the target range is 1 – 3%.

For much of the past few years, the RBNZ failed to achieve the target range, with inflation being lower than the band. This was despite rising house prices, especially in the largest residential property market Auckland. While we had rapid house price increases, low interest rates largely offset this in the CPI calculations that Statistics New Zealand use.

The natural level of interest rates is where inflation is stable and employment is full. Given that we have less than 5% of the workforce being unemployed, and inflation is stable, then our current interest rates could be considered to be at natural levels.

If we believe that the RBNZ had kept interest rates below their natural level for much of the past decade, i.e. post the Global Financial Crisis (GFC), then we should be seeing booming economies, very tight labour markets and rampant wage inflation. This would be akin to what happened in the 1970’s when there was a wage-price spiral following the oil price rise shocks.

New Zealanders became accustomed to high interest rates in the later part of the twentieth century through to the early stages of the GFC. Then the RBNZ made a number of cuts to the official cash rate (OCR) as a means of stimulating the economy. The OCR reductions at that time, lead to what would be considered as artificially low interest rates. They then made a couple of OCR increases, which in hindsight was a mistake as they adversely impacted our economy. It did not take many months before the OCR was reduced to around current levels.

With the current economic conditions in New Zealand, it could be considered that we now have interest rates at natural levels. While Government debt is decreasing, thanks to the growing economy and prudent financial management, household debt is at high levels. This is a real concern. Borrowing has been too easy.

With low unemployment levels, employment prospects are good for skilled workers, so unless interest rates rapidly increase, coupled with a fall in property values there should be few primary house mortgagee sales. It may well be different for overly geared property investors as their debt servicing costs would escalate at a rate much faster than they could realistically increase rents.

So, for investors, what does this all mean? Don’t expect to make high returns from your fixed interest investments. Shares, both domestic and foreign should provide returns at levels well above bank deposit rates. The key will be not to be swayed by greed and stay within your risk tolerance levels. It may prove to be prudent to seek professional guidance to ensure that you do so.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.