14 February
February Finance Newsletter
By John Paine
Last Friday the European Central Bank kept its key interest rate on hold at 3.5% but said “strong vigilance” was needed
to avoid “risks to price stability”. Rates were last raised in December 2006 and economists there are now predicting a
rate rise in March.
The same day the Bank of England’s Monetary Policy Committee voted to maintain the official Bank Rate at 5.25%. The
previous change was a (surprise) increase of 0.25% on 11 January.
Last Wednesday the Reserve Bank of Australia left their cash rate unchanged at 6.25%. The last time official interest
rates were raised there was in November 2006. Commentators are expecting no more rises – but no drop either until late
this year. The Reserve Bank of New Zealand’s next interest rate review is not until 8 March. In its January statement -
when the Bank left rates on hold - Governor Allan Bollard said “While the near-term inflation outlook is relatively
benign, we remain concerned about the upside risks to medium-term inflation. In particular, our assumption that the
housing market and consumer demand will resume their slowing trend over 2007 and 2008 is looking more uncertain,
particularly if further fiscal expansion occurs.”
So what will they do with the Official Cash Rate in March?
Well, all the signs are there should be an increase due to:
* Rising pay rates. Latest figures from Statistics New Zealand show for the December quarter an average increase for
all salary and wages of 5.5%. This is the largest quarterly increase since the index began in 1992. The rise for the
December year is 3.2%.
* Much of the increase in wages is being attributed to labour shortages. A slight drop in employment of only 0.1% for
the December quarter has the unemployment rate at 3.8% - well below the long run average of 6.3%. The labour market is
still tight as a drum. By the way, in Australia the unemployment rate is 4.5% - a new 30 year low.
* Immigration is strong. Annual net migration into New Zealand to December 2006 is 14,610 – up from 6,970 for 2005. This
will put more pressure on the housing market. The fact that the International Travel website rates New Zealand as the
4th best out of 193 countries to live certainly won’t discourage immigration. To see this article CTRL + click here
http://www.internationalliving.com/issues/2007/2007_article.html
* House price inflation is running at 10%. The ASB’s housing confidence survey showed a net 43% of respondents thought
house prices would continue to rise – up from a net 20% for the October survey. Statistics show the housing market has
picked up at the end of 2006. The housing market seems to have found a third wind. These results will be of concern to
the Reserve Bank.
* The ANZ World Commodity Price Index is up 1.3% in January following a 3.8% increase in December. Dairy prices were the
main contributor. This has helped offset the negative effect of the high New Zealand dollar. But people are questioning
how high commodity prices can go or how long the high prices will last.
Housing inflation is clearly a concern for all central bankers and a major reason for interest rate rises in the
developed world. Here in New Zealand the concern is not restricted to the Reserve Bank.
* Affordability is now stretched. The recent study by Demographia found that of the 159 major urban markets in the
U.K., Ireland, the U.S., Canada, Australia and New Zealand, 42 were affordable, 36 moderately unaffordable, 22 seriously
unaffordable and 59 severely unaffordable. All 3 major urban markets in New Zealand fall into the severely unaffordable
category. Interestingly enough the authors say high land prices resulting from government bureaucracy is a major part of
the problem.
To see this article CTRL + click here http://www.demographia.com/dhi-ix2005q3.pdf I think they’ve got a point. Between
1981 and 2004 land prices rose 286% in real terms. If it hadn’t been for that growth house prices would have risen 16.4%
over the 23 year period - instead of the 105% they have actually increased. Of course the high cost of materials
resulting from a virtual monopoly here hasn’t helped the cost of building them.
* Senior BNZ economist Craig Ebert has written an article saying serious questions need to be asked about debt servicing
current housing and farm values in relation to incomes. In the March 2006 year the proportion of income devoted to
servicing debt was 13.1% compared with 7.8% in 2001 and 7.5% in the mid-1990s housing peak. see
http://www.stuff.co.nz/stuff/thepress/3944355a6430.html
I’ve written before about the problem the Reserve Bank has in reducing inflation by raising the Official Cash Rate. Most
house mortgages have a fixed interest rate and are not immediately affected by an increase in the OCR. Michael Cullen
has been making noises about a mortgage levy to slow down the housing market. This is unlikely to fly as it is
complicated, would affect small businesses (which are often financed from house loans), smells of Muldoonism, and would
be very hard to sell to the electorate.
I think it’s too hard right now to call what the Bank will do with the OCR next March. Much will depend on what happens
to the New Zealand dollar over the next few weeks. The Kiwi remains high – driven by the relatively high interest rates
here – and continues to hurt exporters.
A rise in the OCR will encourage a further inflow of funds into the country and keep our dollar up – the last thing
exporters need.
Talking about flow of funds, there’s a few things happening out there that I believe will continue to hold up asset
prices here – including property.
* The world continues to be awash with cheap money. We covered this in our September 2006 newsletter - see
http://www.globalpacific.co.nz/wa.asp?idWebPage=8635=0=179 A
nd it looks like it’s going to stay that way for a while. Much of the cheap money out of Japan, India and China ends up
in countries that have the infrastructure and investment vehicle to handle the volume. See a Business Week article
http://www.businessweek.com/magazine/content/07_08/b4022001.htm?chan=top+news _top+news+index_businessweek+exclusives
For example, China’s trade surplus for 2006 hit a new record of US$177.5 billion – up 74% on 2005 – and it could hit US
$200 million this year.
* The G7 conference this week failed to pressure the Bank of Japan into raising interest rates (their “cash” rate is
currently 0.25%). Cheap Japanese money will continue to fuel Uridashi issues and the carry trade – see September 2006
newsletter referred to above.
* Taxation changes here for listed property vehicles. The new Portfolio Investment Entity regime will allow investors
from 1 October to keep more dividends and pay less tax. Expect more money to be rushed into vehicles like Kiwi Income
Property Trust and ING Property Trust – with new listings being formed.
* Private Equity has grown tremendously over the last few years. Most of the money being invested here comes out of
Australia – driven by the compulsory superannuation there. Sure they’re looking at businesses mainly, but we’re starting
to get the first whiff of interest in large property accumulation funds. Macquarie Bank in Australia has created the
Macquarie Pastoral Fund. This is a wholesale fund marketing to institutions through which it plans to buy large cattle
or sheep stations.
* Aussie super we’ve mentioned above. This is 9% of salary but next June every contributor to this very tax effective
superannuation fund gets a one off chance to put up to $1 million into the fund (and up to $150,000 each year for the
next 4 years after that). Nobody knows how much new money is involved – but it will be huge. And it all needs to be
invested. New Zealand property must be a target for part of it.
* Australia’s biggest non-conforming residential lender is now offering commercial property lending there. This will be
launched in New Zealand next month.
With all this money coming in, it’s difficult to see how property prices are going to come under downward pressure.
Even if the RBNZ raises interest rates in March there is so much competition from banks and new non-bank lenders - who
have access to cheaper offshore money – it’s not a shortage of money that will be the issue for borrowers.
Lenders are becoming more conscious of the risk profile of proposals in a low yield market. There may be pressure to get
the money out but there’s also pressure not to lose it. The structure and presentation of funding proposals is as
important as ever.
Cheers
JP
John Paine B.Sc. Dip BIA Global Pacific Corporation Limited P O Box 3229,
Auckland, New Zealand
Email john.paine@globalpacific.co.nz Web site www.globalpacific.co.nz
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Please note that all opinions and statements expressed in this newsletter are indicative of my opinion only. Global
Pacific Corporation Limited issues no invitation to rely on the information contained in this newsletter and intends by
this statement to exclude liability for any such opinion and statement.
ENDS