2009.05.13 01:02:40
FROM STUFF.CO.NZ
OPINION
Many people will be wondering why it is that the Reserve Bank can cut its official cash rate 0.5 percent yet banks only cut their interest rates by tiny amounts.
In fact the only cuts registered have been for the likes of six month fixed rates with no major bank cutting floating rates.
There are two reasons.
The first is the thing that many months ago rendered continual cuts in interest rates overseas useless.
It now costs us banks far more to borrow money than in the past because of the huge losses racked up by the Northern Hemisphere banks.
This means for instance, as we have noted many times before, whereas we used to pay a premium to offshore investors about 0.1 percent above the bank bill yields and swap rates you might see, now we pay premiums near 2.5 percent.
This means that as old funding rolls off it gets replaced with much more expensive money.
If at the same time as this old money is rolling over the central bank cuts its cash rate the cost to a bank of funding its lending may not go down.
This is why in the United States, even though the Fed has cut its cash rate 5.25 percent, mortgage interest rates have only fallen 1.0 percent to 1.5 percent.
This first factor helps explain why floating rates aren’t falling now and a large gap exists between swap rates and fixed lending rates.
The second factor is the improving outlook for world growth stemming from the green shoots appearing both overseas and offshore.
As the world growth outlook becomes less bad investors move funds into shares.
Where does the money come from? Cash and fixed interest investments.
This means fewer funds available to borrow, which pushes up wholesale interest rates.
In addition, as people now speak about world growth resuming from late this year expectations are building of central banks removing low interest rates from some point in late-2010.
This means investors lending to a borrower at a fixed rate must allow for the lost opportunity created by short term rates rising during the term of their loan.
So they lift what they need to get before lending to the likes of ourselves.
An analogy to describe this is the following: Imagine you are flying a kite on a sloping ground. You are the official cash rate, the kite is a 15 year fixed rate, and the string represents longer and longer terms to maturity of fixed rate loans. If the Reserve Bank cuts the cash rate you walk down the hill and all interest rates fall. But if at the same time you walk down the hill the wind behind you picks up then the kite can settle higher than it was before the official rate cut. These winds represent the outlook for growth, borrower demand, and investor supply.
And so it is that since our central bank cut its cash rate 0.5 percent the ten year swap rate upon which premiums get applied to derive the cost of funds to us banks has risen – that’s right gone up – 0.5 percent.
The five year rate is up 0.3 percent, two year 0.25 percent, and one year 0.15 percent.
Only the person flying the kite is at a lower rate and the fixed rates closest to that rate – out to about six months at most.
Where are things going now?
Our monthly BNZ Confidence Survey has just revealed an equal record level of business sentiment not seen since the early part of September last year.
The green shoots are multiplying both here and offshore.
This easily explains why the NZD has risen back above US60 cents and why fixed home and business lending rates face a greater risk of rising than falling over the coming month or two.
Hence our stark comment in my Weekly Overview of March 19 to – back then – fix now.
I would make the same comment again even though these fixed rates are higher.
Would I float? Hardly – the rate is 1.0 percent above the one year fixed rate.
I would either fix one year if I otherwise would float, or three years now if my plan is to fix.
*Tony Alexander is BNZ’s chief economist.