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Economic Analysis by BNZ chief economist Tony Alexander.
[caption id="attachment_3709" align="alignleft" width="150"] Tony Alexander, BNZ economist.[/caption] The Reserve Bank left the cash rate at 2.5% this morning which surprised no-one. But they did open the door a bit more to cutting further, so although our view remains that they won’t move again, one cannot rule out a 0.25% reduction in March. A lot depends on what happens overseas as domestically our economy has a lot of strength. China remains concerning and weakness there is one reason for still easing international dairy prices and reduced confidence that they will rebound. That loss of confidence lies behind Fonterra’s decision to cut their projected payout from $4.60 to $4.15 which will mean about $800mn less to their suppliers. This week in the housing section I take a quick look again at reasons why Auckland house prices are high and why they will stay high, plus illustrate why cutting migration inflows is not a realistic option for curtailing Auckland’s population growth which is running at twice the average for the rest of NZ. I finish with a look at China, specifically the change in expectations of the rural-urban drift from 5-15 million a year to in fact going into reverse! It looks like analysts on the ground forgot to allow for many “rural” people not in fact still being on farms but having already relocated to “county towns”. The overhang of apartments built in the big cities therefore is a lot more entrenched than previously thought. Hence new worries about debt of developers, regional governments, banks etc. as well as personal wealth held in many (not all) city locations.No Rate Change No Surprise The Reserve Bank this morning undertook their regular review of the official cash rate and surprised noone with their decision to leave it unchanged at the 2.5% level it was taken down to early in December. The rate peaked at 3.5% in July 2014 having been lifted from 2.5% in March. The subsequent 1% reduction last year came about partly because the pace of economic growth turned out to be less than they were expecting, but mainly because the rate of inflation has consistently undershot their expectations. For instance, in the Monetary Policy Statement of March 2014 the Reserve Bank predicted that inflation for calendar 2014 would be 1.9% and for 2015 it would be 2.1%. The actual rate for 2014 was only 0.8%. In March 2015 their forecast for 2015 inflation had been slashed to only 0.4%. As we learnt last week the actual outcome was just 0.1%. That is a full 2% lower than the March 2014 forecast. As previously discussed here, post-GFC the links between growth and inflation have been shattered in many ways, along with growth forecasts themselves almost always being too high. Growth is not quite leading to the sort of jobs growth which would have happened pre-GFC. More importantly, jobs growth is not leading to wages growth which would have happened pre-GFC. Wages growth is also not leading to inflation as would previously have happened and a key reason for that is that businesses can no longer easily put their prices up to recoup wage costs. The cost to consumers of searching for alternative, cheaper, goods and services has been slashed by technology changes and retailer margins have been squeezed – which partly explains why so many chains are going under. In addition energy prices have tumbled courtesy of surging oil supply and demand not growing as previously expected. Will this all change in the very near future and inflation suddenly jump back up again? That does not seem likely and that is a key reason why although we see good NZ growth the next two years of 2.4% each year, we don’t think the Reserve Bank will raise interest rates for a potentially long time. But will they cut them? The markets have priced in a cut as early as March and this cannot be ruled out. But we feel the Reserve Bank will be wary of stimulating the housing market too much, core inflation measures are not as low as the 0.1% headline rate, and it is good to have a 2.5% buffer in case the world economy tips over anew. Still, as noted here now for six years, forecasts of interest rates have proven consistently wrong for a long time now. So try to spread your risk by taking a mix of floating and fixed rates. These two graphs show the good and the bad for borrowers and savers respectively. Housing The annual Demographia Report was issued this week and unsurprisingly it showed Auckland as one of the least affordable cities in the world to live in based upon a comparison of average house prices with average incomes. The usual hand-wringing has occurred, young home buyers have been interviewed, and politicians have either said they are doing something about it, or criticised other politicians for not doing something about it. Enjoy reading all such material if you like, but don’t forget the fundamentals contributing to the issue which will not change for decades. Probably not ever.
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- Low interest rates making it cheaper to service larger mortgages to buy initially larger houses, then after a few years the same house as you would have bought when interest rates were higher. We discount lower interest rates into prices we are willing to pay. Current debt servicing costs nationwide at 9.3% of disposable household income are in fact below the quarter century average of 9.5%.
- Lack of readily buildable land in Auckland either because it is too far away and there is not enough money for a fast transit transport system, or people holding the land see best value long-term in holding it rather than developing it, or because it is flooded – by two large harbours.
- High construction costs in New Zealand as most houses are one-offs and not cookie-cutter properties which we snobbishly turn our noses up at.
- Rapid population growth in Auckland as people seek to live and work in a large agglomeration delivering high interaction with other people rather than staying in the tourism and farming-focussed regions even if working remotely is a possibility. Auckland’s population grew 2.8% in the year to June 2015 and by 14.3% from 2006. Rates for the rest of New Zealand were 1.4% and 7.6% respectively. People are voting with their feet on where they want to be and it isn’t in the regions for a growing proportion of them even though the lifestyle available in the regions is fantastic. Imagine what would happen to Auckland versus regional house prices if a public transport drone pod could take you from your work in Auckland CBD to Mokau in 30 minutes!