The international economic scene is very volatile. The European and U.K markets are still struggling and there is talk of the U.S. economy slipping back into recession.
Economics commentator Rodney Dickens’ discusses the effects this will have on the New Zealand economy in latest Ravings. He says one of the things to be worried about in the U.S. is the banking sector problems. These partly come from falling house prices where banks own millions of houses that have been foreclosed. And this is flowing through to small and medium-sized enterprises (SMEs) that are largely reliant on bank funding.
An implication of the persistency of the financial crisis is the ease and cost of access to overseas funds for New Zealand banks which rely significantly on overseas funding. “We are not predicting another meltdown in the international financial system, but if the U.S. economy experiences a double-dip recession rather than just a growth slowdown, there will be negative implications for the U.S. banking sector, which will have some implications on NZ financial conditions” he says. To read Rodney’s latest Ravings click here.
Here in New Zealand, South Canterbury Finance going into receivership finally gives some certainty to a question that has been hanging over the market for many months now. The receivership triggered the retail deposit guarantee, and the government extended it to include all deposits in the lender. The immediate payout is a massive infusion of equity in the market. The government will ultimately become the sole beneficiary of SCF giving it full control over any sell off or recapitalisation.
Since the demise of the finance companies first started, finance for SMEs has been very difficult here. Much of SCF depositors’ money should flow back to the banks which will hopefully allocate some to financing SMEs.
Interest rates
Westpac economists Brendan O’Donovan and Dominick Stephens have published a series of articles on interest rates which should be compulsory reading for everyone who is in business (or owns a house). And it’s of particular interest now bearing mind the implications of how our banks rely on offshore funding (as mentioned above) and the shortage of debt funding as a result of the demise of the finance companies.
They discuss the conditions before the Global Financial Crisis and after. Here’s my view of the most important conclusions from the four published so far.
The first article “Before and after” explains how the banking system operates (obtains the funds to lend). Banks here obtain funding in three basic ways, retail deposits (only 60% of funding) and the short and long term wholesale markets. Short term wholesale funding is volatile and exposed to rollover risk so banks will now have to pay more for retail deposits and long term wholesale funding.
The second “A matter of interest” examines the practical implications of the new interest landscape. The New Zealand Reserve Bank cannot permanently alter the market determined interest rate while simultaneously keeping inflation stable. So lowering the Official Cash Rate will not reduce the banks’ cost of funds and consequently the cost to borrowers. Over time New Zealand lending and deposit rates will be higher than they would have been previously.
The third “Neutral about neutral” examines the ideal rate for the OCR. There is a yawning amount of spare capacity in the economy and the OCR should be low for a while. But whatever neutral is or isn’t we are a long way from it.
The fourth “Average borrowing costs” predicts more people will migrate to fixed rate mortgages. The OCR will have to be pushed harder to get the desired traction on average borrowing rates. It will ultimately have to head towards 5.75% over the next few years if the objective was to get borrowing costs back to their historic average of 7.7%.
To see these pick on the articles named above under NZ Economic Bulletins here.
So what’s all this mean? Bearing in mind the international troubles mentioned above, expect no increase in the Official Cash Rate until next year but interest rates to gradually rise.
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