Market Watch: Interest rates, inflation dragging on NZX growth

With almost all the local economists tipping three official cash rate hikes between now and Christmas, dealing with a new higher interest rate economy is starting to look inevitable, Pie Funds chief executive Mike Taylor says.

In fact, some are expecting the official cash rate could rise from its current record low of 0.25 per cent to 1.5 per cent by the middle of next year.

That could drive a marked divide between local share market performance and the likes of Wall Street.

New Zealand was increasingly moving out on its own now, Taylor said.

"Other economies around the world don't have this locked border situation," he said. "So if you take the US as one example, there, longer-term interest rates have come down again.

The yields on US 10 year Treasury bonds had risen as high as 1.8 per cent in April but were now back around 1.15 per cent.

"The reason they've come back down is that a lot of the inflation concerns that were out there have abated in recent months," he said.

"Commodity prices, anything from lumber to oil, copper, they've all started to come back down. Some have started to come back down quite significantly. So we're seeing less pressure on the Fed [US Federal Reserve] to hike rates".

That dynamic is giving Wall Street stocks a bit more strength than our local NZX equities.

"Ironically equity markets don't really like economies that are running red hot, because that is forcing intervention to restrict the economy and slow credit."

Markets preferred it when credit was flowing quickly and easily, he said.

"So if rates stay low in the US and they start to rise in New Zealand then we would expect to see the US outperform the NZX ... which is exactly what we have been seeing this year."

Meanwhile, higher interest rates could see a cooling of New Zealand's red-hot housing market, Taylor said.

That was the goal, he said.

"If it cools 5 per cent I don't think that's going to be an issue. It's what the Government wants."

New Zealanders had become accustomed to lower rates, Taylor said.

"We're used to having our fixed mortgage at 2 or 2 and half per cent. If that suddenly became 4, I think that could be significant problem for households."

Taylor said he didn't expect to see the tightening cycle push rates as high as they've had been in the past.

As recently as 2008 two-year fixed mortgage rates have been as high as 10 per cent.

"I don't think we'll be able to cope with that level of rates before the economy starts to significantly cool."

- The Market Watch video show is created in association with Pie Funds