Bernard Hickey: Hitting the brick wall of too much debt

Photo / Bay of Plenty Times

You almost have to feel for Alan Bollard.

Right at the time when he would like to leave his foot on the accelerator to rumble over a few bumps in the road, the government is forcing him to slow down because of the extra chicane it built on the road ahead.

The government's decisions to impose the extra Emissions Trading Scheme costs, the ACC levy increases and the Goods and Services tax hike all within the space of 7 months in the middle of 2010 will push the headline inflation rate to 5 per cent, well over the 1-3 per cent band the Reserve Bank targets.

Bollard rightly points out the Policy Targets Agreement allows him to 'look through' such one-off increases in inflation, but only to the extent that consumers and businesses don't lift their long term inflation expectations.

This is the key. Will New Zealanders believe in their price-setting and wage-expecting bones that the inflationary surge of 2010 is a short term thing?

The initial signs are not good, even by the Reserve Bank's own measures. Here's what it said in its own June quarter survey of expectations of business managers.

"Average one-year-ahead CPI inflation expectations have surged to 2.9 per cent from just 2.1 per cent last quarter. Two-year-ahead expectations have also increased, but less dramatically, from 2.65 per cent last quarter to be 2.80 per cent now, an increase of 0.15 percentage points," the RBNZ said.

Those expectations have blipped up. They have been well above 2 per cent and headed for 3 per cent for most of the current governor's reign. That may not be a coincidence.

The National Bank's Business Outlook survey out yesterday also showed 37.2 per cent of respondents expected to increase prices in the next 12 months, while only 5.8 per cent expected to cut prices and 57 per cent expected them to remain the same.

This, unfortunately, is an ugly combination. The same National Bank survey showed business confidence down for the third month running as the impact of the June 10 rate hike shuddered through the domestic economy.

We simply have too much debt and can't take any more. This was disguised when interest rates were falling. Now the true nature of the indebtedness of the New Zealand domestic economy is laid bare.

New Zealand's household sector is up to its gills in debt to the tune of 155 per cent of disposable income. We hit a ceiling of 159 per cent in the third quarter of 2008 when the Global Financial Crisis struck.

That is no coincidence either.

Over the previous 15 years New Zealand's household sector doubled its house hold debt as a percentage of disposable income. Now we can't take it any more and we don't want any more.

Unfortunately for the New Zealand economy, Alan Bollard can't use the interest rate lever any more to ease the pain and cover up load of debt.

We just have to live with it and dig ourselves out.

It will mean very slow growth in the retailing, construction and other domestically driven parts of the economy.

Luckily for us, and for Bollard, the export sector is steaming up behind. Today's figures show the first surplus in a June for eight years.

Bollard is right to point out to exchange rate markets that the New Zealand dollar's recent rise isn't compatible with a softening in commodity prices.

He, and the export sector, will hope that his warnings about a slowing and lowering of the OCR track will keep a lid on the currency.

So what does this mean for borrowers and savers?

The governor's comments about the more moderate and slower increase in the Official Cash Rate track will be some relief for those up their gills in debt.

But not too much.

On June 10 the Reserve Bank forecast the 90 day bill rate would rise to 6 per cent by the end of 2012, which economists said meant the Reserve Bank expected to increase the Official Cash Rate to 5.75 per cent by then.

Now economists are saying the OCR is likely to rise to around 5 per cent by the end of next year.

That would mean floating mortgage rates would rise to around 8 per cent from around 6 per cent now.

This makes the decision about choosing to fix or float that little bit tougher.

With the two year fixed mortgage rate around 7 per cent at the moment, it's still nominally cheaper initially to go floating at 6.2 per cent, given that floating mortgage rates are likely to go up to 6.2 per cent from 5.9 per cent later this week or early next week.

However, if you expect the OCR to keep rising to 5 per cent by later next year then a two year fixed mortgage rate looks slightly more attractive over the full two year period.

It all depends on your interest rate outlook and your appetite for certainty.

Those who subscribe to the theory that the global and local economy is set for a slow, grinding recovery beset by deleveraging may opt for floating.

Those who see inflationary pressures spiking as central banks print money around the world may opt to fix.

Savers, meanwhile, will be grumpy about the forecasts of a slower and lower rise in the OCR. Term deposit rates of around 5 per cent are set to rise over 6 per cent in the next year, rather than the 7 per cent plus they might have expected.

Although they may well see their rates rise relative to the OCR because the banks are demanding more local and long term savings to meet the Reserve Bank's Core Funding Ratio.

Bernard Hickey