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07 Mar 2014

What to Expect from the Rate Rise

New Zealand has become the first developed nation to tighten its monetary policy, raising interest rates by a quarter percentage point to 2.75 percent.  With inflation pressures increasing and house prices continuing to surge, the Reserve Bank are expecting further increases over the next two years.  While the speed and extent of rate rises will depend on how the economy reacts to this initial move, home-owners will face more pressure as the Reserve Bank seeks to rebalance the economy.
According to many economists, the rate rise is necessary to slow down inflationary pressures from soaring dairy prices, strong immigration, and surging house prices in Auckland.  The NZ$40 billion rebuild of Christchurch also continues to add momentum to the country's economic expansion.  “It is necessary to raise interest rates toward a level at which they are no longer adding to demand,” said Reserve Bank Governor Graeme Wheeler in a statement accompanying the decision. 

Economic growth and inflation projections have both been raised in recent statements, with the Reserve Bank predicting inflation will reach the 2 percent midpoint of its target range 18 months sooner than expected.  “With inflation now rising and inflationary pressures building, there is a need to return interest rates to more-normal levels,” said Wheeler, adding "Inflation pressures are increasing and are expected to continue doing so over the next two years."  GDP rose by 3.3 percent in the year ending February, with 4.1 percent growth forecast for 2014 and 3.5 percent for 2015.

In its monetary policy statement, the Reserve Bank said the official cash rate would need to rise "about 2 percentage points" over the next two years.  With the next rise expected in April and further increases likely in the second half of the year, borrowers will feel the pressure of policy tightening sooner rather than later.  Some economists are expecting interest rates to rise by 150 basis points this year alone, with others forecasting 3.75 percent by December.

With most outstanding mortgage lending on floating or short-term loans, any rate hikes will be passed on directly to borrowers.  Floating-mortgage rates are currently about 5.75 percent, and could easily rise to about 8 percent in the next couple of years.  If rates do rise as fast as expected, there is likely to be an increase in demand for fixed mortgages, as borrowers look to shelter themselves from future rises.  If the cash rate does rise by 1 percent this year, householders can expect to spend another $20 a week for every $100,000 borrowed.  

According to Prime Minister John Key, interest rate rises are a sign of a strong economy:  "It's true we are the only developed country in the world that's currently raising interest rates, but that's because we are growing at a faster rate than most other countries around the world and we've got a very robust outlook...  So while I think there will be some disappointment and frustration from home-owners, on the other side of the coin they can take real confidence that the strong economy will underpin good job opportunities and probably wage growth over time."