Latest / The SME Stream / How low will interest rates go [VIDEO]

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How low will interest rates go [VIDEO] · The SME Stream

• 0:00
  Speaker 1: The information provided in this program is of a general
• 0:02
  Speaker 1: nature and it is not intended to be personalized financial advice.
• 0:05
  Speaker 1: We encourage you to seek appropriate advice from a qualified
• 0:07
  Speaker 1: professional to suit your individual circumstances. We're about to enter
• 0:11
  Speaker 1: an economic unwinding, with the market aggressively pricing in multiple
• 0:16
  Speaker 1: rate cuts this year, but it's unlikely to take us
• 0:19
  Speaker 1: back to that cheap money era where interest rates were
• 0:22
  Speaker 1: close to zero.
• 0:23
  Speaker 2: Yeah, that period was the outlier, and people who need
• 0:26
  Speaker 2: to keep that in mind, so when they're thinking about
• 0:27
  Speaker 2: where we can get back to the world's changed significantly.
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  Speaker 2: Thank goodness, we don't want to get back to zero.
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  Speaker 2: Zero was not a good place to be. Central bankers
• 0:35
  Speaker 2: certainly didn't want to be there because then you end
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  Speaker 2: up with all the unconventional policy solutions that of course,
• 0:40
  Speaker 2: we're now trying to unwiden all the issues that we
• 0:43
  Speaker 2: have with that.
• 0:55
  Speaker 1: The US Federal Reserve kept rate steady last week, but
• 0:59
  Speaker 1: is expected to start moving them lower later this year,
• 1:02
  Speaker 1: in line with the downward trend in central banks. Measure
• 1:05
  Speaker 1: of inflation, including here, annual growth in our consumer price
• 1:10
  Speaker 1: index is at three point three percent, less than half
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  Speaker 1: the seven point three percent peak from twenty twenty two.
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  Speaker 1: But our economy is ugly. Unemployment is ticking up, while
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  Speaker 1: consumer spending and house values are in decline. The services
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  Speaker 1: and manufacturing industries are contracting quickly, with the period of
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  Speaker 1: pain they've experienced now longer than the GFC. That's clearly
• 1:37
  Speaker 1: put us on course for rate cards, and the wholesale
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  Speaker 1: interest rate market is massively pricing it in, with the
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  Speaker 1: ocr expected to fall from the current five point five
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  Speaker 1: percent to three point seventy five percent within a year.
• 1:51
  Speaker 1: The two year swap rate recently hit a two year low,
• 1:55
  Speaker 1: leading some major banks to lower their retail rates. That
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  Speaker 1: means the market is doing some of the Reserve Bank's
• 2:01
  Speaker 1: unwinding work for it, bringing relief to borrowers, but it
• 2:05
  Speaker 1: also may demand at move soon. Whenever it does, that
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  Speaker 1: would mark the end of one of the most rapid
• 2:12
  Speaker 1: and restrictive rate hiking cycles our economy has ever seen.
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  Speaker 1: Shaun Keen watches the rates market closer than anyone I know.
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  Speaker 1: He expects the Reserve Bank will have to respond to
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  Speaker 1: our economy soon. Shawn, good to see you, Thanks so
• 2:28
  Speaker 1: much for having us out. Good to be back.
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  Speaker 3: Thanks you, Madison. It's great to be there.
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  Speaker 1: It seems like it's consensus now that cuts are coming
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  Speaker 1: this year.
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  Speaker 3: Is that corrects? Yeah? Absolutely, The market's pricing in pretty aggressively.
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  Speaker 1: What is your forecast. I'm assuming you're picking November, and
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  Speaker 1: if so, to what degree?
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  Speaker 2: Yeah, I mean, I think they'll cut it by November
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  Speaker 2: at the latest. All year, I've thought probably fifty basis
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  Speaker 2: points in November, because there's a very long gap between
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  Speaker 2: the November monetary policy statement and February when.
• 2:53
  Speaker 3: They come back.
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  Speaker 2: So I thought fifty at the end of the year
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  Speaker 2: would be right, and then they come back again in February,
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  Speaker 2: probably another fifty the market it's a little bit earlier now,
• 3:01
  Speaker 2: So the market's fifty to fifty in terms of probabilities
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  Speaker 2: for an August rate cut, which is pretty early, and
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  Speaker 2: then it's fully priced by October and again in November.
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  Speaker 2: So we've got about seventy three basis points of easing
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  Speaker 2: by the end of this year.
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  Speaker 1: Yeah, you've been pretty early on this on looking at
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  Speaker 1: the data and assuming that cuts are going to have
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  Speaker 1: to come this year. What did you see that other
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  Speaker 1: economists didn't.
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  Speaker 2: I think, you know, one of the benefits of my
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  Speaker 2: role as I look overseas as well as looking domestically,
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  Speaker 2: and it was apparent to me that not only was
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  Speaker 2: the overseas markets overseas economy starting to slow, but that
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  Speaker 2: the general picture of interest rates was probably peaking. You know,
• 3:40
  Speaker 2: these things move in cycles, so as we started to
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  Speaker 2: turn overseas, I thought it was probably going to happen here.
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  Speaker 2: And the analysis of the data here domestically was pretty weak.
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  Speaker 2: You know, what kept the RBNZ where they were was inflation,
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  Speaker 2: and the inflation number is there mandate, that's what they
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  Speaker 2: focus on, but the underlying activity levels in the economy
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  Speaker 2: were really.
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  Speaker 1: Weak and completely out of the picture. No, how likely
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  Speaker 1: is that do you think, Well, the.
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  Speaker 3: Market's fifty to fifty. I think it's too early.
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  Speaker 2: I think it's very hard for any central bang to
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  Speaker 2: go from talking about hiking rates at the last monetary
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  Speaker 2: policy statement in May, which is what they did, to
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  Speaker 2: suddenly cutting in August without some sort of big global event.
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  Speaker 2: So I think what you're going to see is a
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  Speaker 2: change in tone, a sharp change in tone and forecast.
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  Speaker 2: But I think they'll leave the OCO where it is.
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  Speaker 1: You mentioned inflation, and we know that CPI is paramount.
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  Speaker 1: The headline figure is going in the direction that the
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  Speaker 1: RBNZ wance and expected it too. That's good news effectively,
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  Speaker 1: but can we trust them.
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  Speaker 2: Yeah, the I mean all that data as subject to revision.
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  Speaker 2: As you know, medisin better than me at different times
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  Speaker 2: in different cycles. Inflation's affected by different things. So we've
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  Speaker 2: got a number of different metrics for our inflation. So
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  Speaker 2: we have headline inflation, we have core that the RBNS
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  Speaker 2: that look at, and then we've got the two subcomponents
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  Speaker 2: of tradable and non tradable. Now, the inflation rate is falling,
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  Speaker 2: so we're at three point three percent, which is great.
• 5:00
  Speaker 2: The rbnz's target rate is to get it back to
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  Speaker 2: two percent, the midpoint of their target band to one to.
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  Speaker 3: Three, so they're a little bit higher.
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  Speaker 2: The projection suggests that we're going to be back inside
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  Speaker 2: the one to three percent banned by the end of
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  Speaker 2: this year, which is great. But the rbnz's focus has
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  Speaker 2: been on getting back to two and two is a
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  Speaker 2: long way from three point three.
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  Speaker 3: Now.
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  Speaker 2: To get to two, we've got to have both tradable
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  Speaker 2: inflation and non tradable inflation falling. Tradable inflation is driven
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  Speaker 2: by global factors largely outside of our control, so things
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  Speaker 2: like our international prices that feed through to New Zealand.
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  Speaker 2: That's down at zero point three percent. It's already about
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  Speaker 2: as low as it can go. Non tradable, which is
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  Speaker 2: domestically domestic factors, that's at five point four and the
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  Speaker 2: rbnz's reluctance to ease or to give softer guidance has
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  Speaker 2: been because of the stickiness of non tradable inflation.
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  Speaker 3: So they need that to come down.
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  Speaker 1: So it's not just a matter of getting within that
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  Speaker 1: target range, it's a matter of staying to.
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  Speaker 2: Absolutely so, I mean, Adrian has been very clear and
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  Speaker 2: the NPC have been very clear that it's not just
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  Speaker 2: about getting to two and then bouncing off it. It's
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  Speaker 2: about getting to two and staying there. So and that
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  Speaker 2: again is part of that hawkish message. So they gave
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  Speaker 2: last May.
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  Speaker 1: But that headline inflation figure worth a three in front
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  Speaker 1: of it. You know, everyone's kind of screaming from the
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  Speaker 1: rooftops that that's awesome news. Not the Reserve Bank quite yet,
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  Speaker 1: but that official cash rate has a five in front
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  Speaker 1: of it. So that spread, that discrepancy kind of demands
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  Speaker 1: that they have to cut anyway, is it not?
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  Speaker 2: Yeah, I think you know, One of the reasons I
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  Speaker 2: believe that the monetary policy is achieving traction is that
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  Speaker 2: the spread is so wide between not only current inflation
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  Speaker 2: but the projected inflation rate. So if you look at
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  Speaker 2: the rbnz's last set of projections in May, by Q
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  Speaker 2: three of next year, they've got the OCR unchanged at
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  Speaker 2: five and a half, but inflation is down at two
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  Speaker 2: point two. So you've got this enormous three hundred odd
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  Speaker 2: basis point spread between the two.
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  Speaker 3: Normally you would expect it to.
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  Speaker 2: Be around one hundred and sixty basis points, around about
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  Speaker 2: half of what it is, and I think it's going
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  Speaker 2: to get back there. So my expectation is that the
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  Speaker 2: RBNS that will lower their projections for the OCR, so
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  Speaker 2: they set around about one hundred and fifty to one
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  Speaker 2: hundred and sixty basis points above where they think inflation is.
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  Speaker 2: And if you think inflation is going to be two
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  Speaker 2: by the middle of next year, well that puts the
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  Speaker 2: cash rate somewhere around three and a half two hundred
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  Speaker 2: points below where we are today.
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  Speaker 1: And did other spreed that you have been quite vocal
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  Speaker 1: on calling out is coming to those oc our projections
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  Speaker 1: and what the Reserve Bank has stated on paper versus
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  Speaker 1: what the market is actually priced in, very big sea
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  Speaker 1: gap there. Explain that to me, How did the market
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  Speaker 1: price something so differently to what the rb itself did.
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  Speaker 2: Yeah, I mean, I think one of the challenges that
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  Speaker 2: the RBNS has had is that the May Monetary policy
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  Speaker 2: statement was surprisingly hawkesh for an economy that was in recession.
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  Speaker 2: I mean, four of the last seven quarters have been
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  Speaker 2: negative growth. Six of the last six quarters we've had
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  Speaker 2: negative per capita growth, and the market is looking at
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  Speaker 2: this and saying this economy is slowing very far. It
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  Speaker 2: started to building easings and then the RBNZ came out
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  Speaker 2: with the monetary policy statement that talked about hiking interest
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  Speaker 2: rates and it's slightly raised at socr path. Now, there
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  Speaker 2: were various reasons for that, including a reassessment of the
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  Speaker 2: amount of spare capacity that we have in the economy,
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  Speaker 2: but I think those concerns are gone now. Even though
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  Speaker 2: that was only in May, it's pretty clear now that
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  Speaker 2: we're slowing really fast. So the most recent BNZ pmis
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  Speaker 2: and PSI's the PSI, the Performance of Service Index that
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  Speaker 2: just printed at forty, which is the lowest that's ever
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  Speaker 2: been outside of the COVID period, so domestic activity is
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  Speaker 2: extraordinarily weak. So the market's been looking at the activity levels,
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  Speaker 2: and it's been assuming that the RBNZ will get the
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  Speaker 2: inflation traction that it expects.
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  Speaker 1: Is it unfair or fear to say, then, based off
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  Speaker 1: that assissement that the Reserve Bank has kind of been
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  Speaker 1: blinded or blind to the ugliness of the economy that
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  Speaker 1: people on the market like yourself have clearly seen.
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  Speaker 3: For a while. No, I wouldn't be that harsh on them.
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  Speaker 2: I think, you know, they've got one mandate specifically, which
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  Speaker 2: is inflation.
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  Speaker 3: They're adjacent to that.
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  Speaker 2: They've got to achieve their objective without causing undue volatility
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  Speaker 2: in a bunch of other variables, including output, interest rates,
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  Speaker 2: in the exchange rate, so they can't be blind to
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  Speaker 2: what's going on elsewhere in the economy, and that includes unemployment.
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  Speaker 2: Unemployments at four point three the RBNS, they think it
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  Speaker 2: will be five by the end of the year. I
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  Speaker 2: suspect that might move a little bit higher than that,
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  Speaker 2: and we might actually push, you know, quite quickly in
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  Speaker 2: next year up towards five and a half. Now, historically
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  Speaker 2: our twenty five year average is five point two, so
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  Speaker 2: right now, unemployment is still pretty low. So if you
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  Speaker 2: like this room for unemployment to go up without it
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  Speaker 2: being an outlawer. But the bank's focus has to be
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  Speaker 2: on inflation because that's what their mandate requires. The question
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  Speaker 2: is being in the band sufficient or do they need
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  Speaker 2: to be at two percent For a long time they
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  Speaker 2: talked about two percent the market of things being in
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  Speaker 2: the band is satisfactory.
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  Speaker 1: I did want to ask you about how all of
• 9:59
  Speaker 1: that other data, economic data intersex into Central Bank thinking
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  Speaker 1: as well. You've already mentioned labor market statistics and what's
• 10:05
  Speaker 1: happening with employment. How much weight do they place on
• 10:08
  Speaker 1: all of the other things, including asset prices as well.
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  Speaker 2: Yeah, I mean everything obviously folds in ultimately to what
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  Speaker 2: the rbns that are looking at, and that's concentrated in
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  Speaker 2: one number, which is the inflation number. So it all
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  Speaker 2: has an impact and it's a necessary part of what
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  Speaker 2: the Reserve Band does that they monitor all acset price
• 10:26
  Speaker 2: changes across the economy. Now, some of them are more
• 10:28
  Speaker 2: immediate in their impact, some of them.
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  Speaker 3: Are more long term.
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  Speaker 2: The big one in New Zealand's obviously house house prices
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  Speaker 2: are the key asset for most households, and Adrian, to
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  Speaker 2: his credit, when he took over as RBNS at governor,
• 10:42
  Speaker 2: talked about the fact that as a country we can't
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  Speaker 2: get rich selling houses to one another.
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  Speaker 1: We're trying, though, aren't we.
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  Speaker 2: We tried for a long time, and when we had
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  Speaker 2: foreign people coming in and buying houses office sometimes you
• 10:53
  Speaker 2: do get an appreciation in terms of your evaluation because
• 10:56
  Speaker 2: you sold it to a new entrant. But generally, in
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  Speaker 2: a closed circuit economy closed economy, if I sell to
• 11:02
  Speaker 2: you and you sell to somebody else, there's been no
• 11:04
  Speaker 2: appreciable change in value. They've been very clear that getting
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  Speaker 2: house price appreciation under control was one of the objectives
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  Speaker 2: of tighter policy, and they've done that. And again, Adrian,
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  Speaker 2: to his credit, was probably the most honest central banker
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  Speaker 2: in the world in saying we need a recession. I mean,
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  Speaker 2: my goodness, Jo Powell couldn't say that in the United States,
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  Speaker 2: and there's no way that wouldn't There's no way that
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  Speaker 2: Michelle Bullet could say that in Australia, but Adrian said
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  Speaker 2: it here and most people agreed inflation was too high.
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  Speaker 2: Now part of getting inflation under control is getting house
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  Speaker 2: price growth under control and they've achieved that with a
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  Speaker 2: very rapid appreciation in the OCR which is fed through
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  Speaker 2: to mortgage rates. Because in New Zealand we had a
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  Speaker 2: very high percentage of fixed rate mortgages. It took monetary
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  Speaker 2: policy the best part of two and a half years
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  Speaker 2: to really get traction, and so at the first half
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  Speaker 2: of this year the RBNZ were pretty clear that they
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  Speaker 2: were waiting for the large mortgage refinancing role to take
• 12:02
  Speaker 2: place and that they wanted to keep rates where they were.
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  Speaker 2: That's largely happened now, which is a good thing from here.
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  Speaker 2: I think as interest rates starts to come off, you know,
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  Speaker 2: people talk about is it time to get back into
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  Speaker 2: housing again? Is it going to take off? I don't
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  Speaker 2: think it will in the same way that has in
• 12:19
  Speaker 2: the past. And there's a few different things that have changed.
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  Speaker 2: Principally the RBNS. It's macro prudential tools have changed. So
• 12:26
  Speaker 2: they've had LBRs for a while now, so loans of
• 12:29
  Speaker 2: value ratios. That's an efficient and effective tool. But with
• 12:33
  Speaker 2: an LVR, as house prices appreciate, your ability to borrow
• 12:37
  Speaker 2: increases as well, you can leverage against the asset. The
• 12:40
  Speaker 2: new tool they have is debt to income ratios and
• 12:43
  Speaker 2: debt to income ratios have a degree of power that's
• 12:46
  Speaker 2: multiples of the LVR. So your house price can go
• 12:49
  Speaker 2: wherever you like, but unless your income increases, you cannot
• 12:53
  Speaker 2: borrow more. And they've got the approval to use that.
• 12:55
  Speaker 2: They haven't used it yet, but that will give them
• 12:57
  Speaker 2: a lot of confidence that if the market starts to move.
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  Speaker 3: They can rein it.
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  Speaker 2: In the other one is our external position has changed
• 13:05
  Speaker 2: in that we're not as welcoming with foreign money. So
• 13:07
  Speaker 2: in estra in New Zealand or an Australian or a Singaporean,
• 13:11
  Speaker 2: you can't buy in most property in New Zealand. And
• 13:14
  Speaker 2: you compare that with Australia where their house prices are
• 13:16
  Speaker 2: obviously appreciating significantly. But sus us that's the impact of
• 13:20
  Speaker 2: foreign buyers now. Different people have got different views about
• 13:23
  Speaker 2: whether that's a good or bad thing, but the reality
• 13:25
  Speaker 2: is they can't come in right now, so our house
• 13:28
  Speaker 2: prices are pretty flat.
• 13:29
  Speaker 3: That's the rules.
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  Speaker 1: This all speaks to how restrictive the economy and the
• 13:34
  Speaker 1: rains on it are going to remain even if and
• 13:37
  Speaker 1: when interest rates reduce. Right, what kind of a flaw
• 13:42
  Speaker 1: do you think the Reserve Bank will allow this cycle
• 13:45
  Speaker 1: to end at noting that we're certainly kind of not
• 13:48
  Speaker 1: in a reflective phase yet because we're still kind of
• 13:50
  Speaker 1: in it at the moment. But I think it's fair
• 13:53
  Speaker 1: to say that it's not going to be back to
• 13:54
  Speaker 1: that zero interest rate asset price inflation era that we once.
• 13:57
  Speaker 2: Had, right I don't think so that period was the outlier,
• 14:01
  Speaker 2: and people need to keep that in mind so when
• 14:03
  Speaker 2: they're thinking about where we can get back to the
• 14:05
  Speaker 2: world's changed significantly, Thank goodness, we don't want to get
• 14:08
  Speaker 2: back to zero. Zero was not a good place to
• 14:10
  Speaker 2: be in Central bankers certainly didn't want to be there
• 14:12
  Speaker 2: because then you end up with all the unconventional policy
• 14:15
  Speaker 2: solutions that of course, we're now trying to unwind all
• 14:18
  Speaker 2: the issues.
• 14:18
  Speaker 3: That we have with that.
• 14:19
  Speaker 2: So the rbnz it's latest assessment of the long term
• 14:24
  Speaker 2: neutral interest rate is two and three quarter percent two
• 14:26
  Speaker 2: point seventy five. Shorter term, I think it's probably three
• 14:30
  Speaker 2: to three in a quarter. So in this cycle we
• 14:32
  Speaker 2: probably get down to about three to three and a quarter,
• 14:35
  Speaker 2: but there's some risk that it could end up higher
• 14:39
  Speaker 2: than that because as the world changes and it is changing,
• 14:42
  Speaker 2: and you know, we don't know what's going to happen
• 14:44
  Speaker 2: with future trade agreements and the US view of how
• 14:47
  Speaker 2: it wants to trade with the world. The efficiencies that
• 14:51
  Speaker 2: we get from trading internationally, they diminish as borders close.
• 14:55
  Speaker 2: So a big part of the deflation that we've all
• 14:58
  Speaker 2: enjoyed over the past forty years been the opening up
• 15:00
  Speaker 2: of global markets, the ability to arbitrage away costs. If
• 15:04
  Speaker 2: it's cheaper to produce something in Malaysia than in Melbourne,
• 15:08
  Speaker 2: you do it in Malaysia. If it's cheaper to make
• 15:11
  Speaker 2: something in Europe rather than in New Zealand, you do
• 15:13
  Speaker 2: it in Europe. You can do that when markets are
• 15:16
  Speaker 2: open and you've got free movement of goods, services, and labor.
• 15:19
  Speaker 2: As borders close, as trade restrictions are put in place,
• 15:23
  Speaker 2: you don't have that same ability, and domestic prices rise
• 15:27
  Speaker 2: and on shoring, which is what the Americans are doing
• 15:29
  Speaker 2: and the Australians are doing now as well with some
• 15:31
  Speaker 2: things that will raise domestic prices.
• 15:34
  Speaker 1: Interesting, So this unwinding, this easing, it's not like any
• 15:39
  Speaker 1: other time before because the world is different during politically.
• 15:43
  Speaker 2: Some different dynamics. What we've had over the past forty
• 15:45
  Speaker 2: years was different from anything we saw before. We brought
• 15:48
  Speaker 2: the world's second biggest economy into the global market. It
• 15:52
  Speaker 2: wasn't the second bigst economy at the time, but it
• 15:54
  Speaker 2: is now China. We brought it into the global market,
• 15:57
  Speaker 2: and it created massive deflation globally. While as borders start
• 16:01
  Speaker 2: to close, trade borders start to close, that goes into
• 16:04
  Speaker 2: reverse to some extent, not to the whole extent, but
• 16:07
  Speaker 2: to some extent.
• 16:08
  Speaker 1: Looking at our system, it survived relatively well. We jacked
• 16:13
  Speaker 1: up rates at a pace kind of unseen before really,
• 16:17
  Speaker 1: and also keep them at a height for a length
• 16:20
  Speaker 1: of time that's surprised pretty much everybody in the market,
• 16:23
  Speaker 1: most economists and banks certainly. What do you think we've
• 16:27
  Speaker 1: learned about monetary policy and the way in which it.
• 16:30
  Speaker 3: Can be used. That's a great question.
• 16:32
  Speaker 2: I think the learning is one be active when you
• 16:36
  Speaker 2: need to be active. So the Reserve Bank Act did
• 16:39
  Speaker 2: in New Zealand quicker than most central banks around the world.
• 16:42
  Speaker 2: In my view, they were still too slow. I would
• 16:44
  Speaker 2: have liked them to have been more active, more quickly
• 16:47
  Speaker 2: on the way down. Now they're going to have the
• 16:48
  Speaker 2: same challenge. So the market is obviously running well ahead
• 16:52
  Speaker 2: of them because one of the markets sees is that
• 16:54
  Speaker 2: the economy is heading a wall. Unemployment is going to
• 16:57
  Speaker 2: go up very quickly, Inflation is going to come down
• 16:59
  Speaker 2: very quickly. The longer the RBNZ takes to unwind the
• 17:03
  Speaker 2: hikes to get back down for about three and a half,
• 17:05
  Speaker 2: the longer it takes, probably the lower they'll have to go,
• 17:08
  Speaker 2: so the cycle will be extended. So faster movement is
• 17:12
  Speaker 2: probably better because the transmission mechanism seems to be much
• 17:15
  Speaker 2: quicker than it used to be. You know, Central manks
• 17:17
  Speaker 2: still talk about monetary policy taking fifteen months.
• 17:21
  Speaker 3: Or so to have an impact.
• 17:23
  Speaker 2: You know, my strong impression of it now is it's
• 17:25
  Speaker 2: probably close to six to nine months because market pricing
• 17:28
  Speaker 2: does the work for you.
• 17:29
  Speaker 1: A lot to watch, worrying wade about Shorty as always,
• 17:32
  Speaker 1: Thank you so much your time.
• 17:33
  Speaker 3: I appreciate it all right, thank you,