This month we are really thrilled to introduce a new monthly piece written by Tony Alexander. Tony is an Independent Economist known for his accessible commentary on the New Zealand economy. Each month he will be writing a piece for Isbister Partners that we will distribute to you.
Back in 2019, well before any of us had heard of Covid-19, the Reserve Bank cut its official cash rate from 1.75% to 1.0%, causing the likes of one-year fixed mortgage rates to fall from 4.1% to 3.39%. They cut partly because business confidence fell away sharply that year (though the economy held up well), and because inflation turned out lower than expected at the turn of 2018.
The Reserve Bank has a record of reacting to rogue inflation outcomes and that is what we saw appear on July 16. The annual inflation rate jumped to 3.3% from 1.5% which was 0.5% more than commonly expected. This is a rare thing to happen and by itself justifies a quick start by the Reserve Bank to at least removing last year’s extra 0.75% cut in the cash rate to a record low of 0.25%.
But we also just two weeks ago saw the unemployment rate fall much further than expected to now sit at the 4% it was at before the nationwide lockdown. Add in many other measures showing inflation rising, along with worsening supply chain problems globally expected to further boost shipping and materials costs, and we have a perfect storm justifying quick interest rate rises.
How quick? In 2014 the Reserve Bank raised the cash rate 1.0% in a five-month period. Could they do the same again? That is impossible to know. But borrowers should anticipate that at a minimum the Reserve Bank will look to reverse the 1.5% worth of interest rate cuts over 2019-20 within the next 18 months at the very longest.
Given the intensity of inflation risks, the chances are they may have to raise further than that. So, for those borrowers who have done very well simply rolling at one-year fixed rates since 2008, a rate perhaps above 4.5% should be allowed for come late-2022.
For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz
As you have heard from Tony, inflation is of concern and that is why interest rates are predicted to rise. Given a generation of New Zealanders have mainly only seen interest rates move one way we thought we would give you a heads up on what you may see going forward.
When interest rates start to rise, the impacts flow through to your investments. With higher interest rates, people have less money to spend as borrowing becomes more expensive. They can’t borrow as much. That also means they can’t borrow as much to buy a property as well.
All of this has an impact on your investments. So, what may you see happen?
If people aren’t able to borrow more to buy property, then they are not able to pay as much for property. We may see the property market stall as buyers and sellers reach a new equilibrium. We have already seen one fund manager move funds allocated into property into other asset classes.
Bonds are like term investments, you invest(lend) a sum of money at a set rate of return to a company or government agency. One key difference is they can be bought and sold on an exchange. Typically, when interest rates rise, bond holders have to sell their bond at a discount to match higher yields (interest rates) on offer. Therefore, you may see bond portfolios drop in value over the short term.
As interest rates rise, and more money is withdrawn from circulation, people have less demand for goods and services. Companies earn less revenue from trading, and this impacts on their share value.
All of these assets are good to have in your portfolio depending on your risk profile. Shares and property deliver good capital growth over the long term, with property typically providing good cashflow as well.
Bonds often deliver good capital preservation as a defensive asset. Historically they have delivered good growth over the long term, being ten years plus. Since 1971, the annualised growth of the various asset classes has been: New Zealand equites 12.6%, world equites 11%, Australian equities 10.8%, world bonds 8.4%, residential property 9%.
You may expect some volatility as interest rates rise across all asset classes until they stabilize. There is strong underlying demand causing the inflation which we may see normalize. Unless your situation has changed or you are nearing your goal, stick to your investment strategy.
Disclaimer: This newsletter is meant to be informative and engaging, hopefully not a cure for insomnia. Please don’t take this as personalised financial advice. Discuss your situation with an Advisor. This is where I need to say past returns are no guarantee of future returns.