Hi [salutation],
The good news is that recent interest rate cuts are now starting to work their way through to borrowers and coupled with next months tax cuts should provide some relief for all- the bad news is that this recession still has a little way to go yet...
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75 or 100bp seems to be the only question about next weeks OCR Review. Personally I think Bollard will go for a full 1% cut again. Since he began this round of aggressive cuts little has happened to change his view that the best path forward is to front load the easing cycle and recent economic data both domestically and internationally continues to support this view. Unemployment is now starting to rise with redundancies in the banking, construction and media sectors increasing strongly. Internationally the banking sector continues to suffer massive right downs and our exporters are already coming under earnings pressure as overseas consumers shut up shop. With absolutely no good news to be found anywhere it is hard to see why Bollard would not continue to front load cuts in the abscence of any reason not to.
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2. If I was a borrower...
I would hang out for another couple of months and see if I can get a 5 year fixed rate at about 5.5%. With bank margins now swelling to 250bp I would be surprised if the competitive battle ground for customers (historically the 2 year fixed rate) doesn't shift out further on the curve- if I was a bank and I could lock in my loan book for 5 years at a margin of 250bp I think I might do that. This has enormous implications for bank profits when you consider that historically about 80bp is regarded as normal and in recent years margins of about 40bp became the norm. It will be interesting to see the impact on their earnings as their current loan books refix- all of a sudden their existing loans are starting to look very profitable...
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3. Pricing- Fixed vs Floating
Alot of people ask me why the difference in pricing between floating and fixed- the reason is relatively simple but is rarely explained. The key reason is that the money that funds them comes from 2 different places and is bought at 2 different prices. Floating rates are funded largely by money borrowed from the Reserve Bank at the level set by the RBNZ- the OCR. Presently this is 3.5% which when you add the banks margin of 300bp gets you to about 6.5% which is where most retail rates currently sit. Fixed rates are funded by money borrowed from offshore- usually from other banks. The pricing on these is based on the cash rate in those countries- in the UK and USA it is currently .025%. From there NZ Banks pay a risk premium based on how risky the deal is- this is usually calculated by country. NZ is seen as having significant risk as it is a small economy with a large current account deficit (we spend more than we earn and top things up by borrowing- not a great strategy for a household and the same applies for a country). Consequently we pay about 300bp. The local banks then add their margin on top of that- presently about 250bp and that gets you your fixed rate of 5.75%. The only real flexibility is in the local banks margins and this is dictated by competitive pressure- how much are they prepared to give up to get the business? Thats why I suspect the 5 year rate will become the battle ground- they can give up 50bp and still refix their existing loan books and double their revenue streams coming off that book at an acquistion cost of close to zero. In an environment where funds are hard to come by it sounds like a plan to me...
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Keep your head down out there...
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Adam Parore
Managing Director |
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