Hi [salutation],

The past week has been one of the more active in recent memory in terms of both the interest rate environment and the money markets specifically- with various implications for borrowers and home owners generally. The course of events and my view on how they will affect you is as follows; 

Unfortunately it appears as if things are starting to lose their shape. Bollard has now clearly indicated that despite two consecutive rises in the OCR to a record 8% he is prepared to keep going until we see a sustained and across the board weakening in the domestic economy and especially the housing market. This now means we have floating rates of 10.3% and fixed rates ranging from 9.3% to 8.9%. In terms of this tightening cycle, rates have been on the rise since 2004 so we are a fair way into it. Further rises now depend on if the economy responds accordingly.

My view is that we will cop one more rise next month, but that thereafter the required softening in the data will begin to show through. This will take a little time, although the anecdotal evidence is already appearing, hence we will be in the gun again once more.

I would go short and fix for 1 Year at about 9.3% with the view that you can then benefit from any easing in rates next year. By that stage you might pick something up under 9% if we get lucky. The trick now is to pick the top of the cycle, which requires a combination of witchcraft and good luck. My instincts are that we are almost there and my gut feel is that when it turns it will turn fast and hard. If that happens rates will come back down as Bollard tries to keep the economy moving.

I believe Bollard has failed to factor into his approach one key ingredient that no financial model will show him- Kiwi's are not very confident people, and when you ding their confidence they take a while to find their feet again. Consumer confidence is the key to a strong economy and I think that sooner or later it will take a big hit as a result of recent high interest rates, his meddling with the exchange rate (more on that later but it freaks people out) and his vocal and sustained attack on housing, which is at the heart of how we value ourselves financially. If the economy is a 747 coming in to land the risk at present is that we hit a downdraft and the bum hits the deck before the wheels. If that happens it will be a year or two before we recover. 

Those of you who have been living under a rock for the past few days will probably be alarmed to learn that the Reserve Bank has intervened in the currency markets for the first time in 20 years in an attempt to keep the Kiwi at or below what appears to be US75c.

The move has been applauded by exporters and politicians who are sick of getting it in the neck about ruining our export industry- or whats left of it. A few key questions:

Did it work? It worked a couple of nights ago, but its a bit like Blackjack Theory- if you back red, even if you lose, so long as you keep doubling up, you have to break even eventually. Unless you run out of money first that is. Bollard has only so much to bet, so eventually he's going to run out bucks.

What does it mean? Well, it puts Bollard in a bit of a pickle. Will he continue to raise rates as predicted, even though this will put upward pressure on the Kiwi? Maybe not. Or will he continue to raise rates and then sell the Kiwi to quell the upward pressure he has created? It's a bit of a hick approach to economics, and will make the purists cringe, but its a pretty effective way of having his cake and eating it too. Unless he runs out of money. If that happens the Kiwi will get creamed as the speculators buy it with their ears pinned back and he'll look like (more of) an idiot. It's high risk, and even though I know I shouldn't, I like it.  

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