Interest rates likely to move higher while RBNZ stays on hold

Deputy Reserve Bank Governor Grant Spencer. Photo / Jason Oxenham

Interest rates look set to rise, regardless of the outcome of today's official cash rate review by the Reserve Bank.

Economists do not expect the bank to change the rate - which sits at 1.75 per cent - but they said other factors, such as higher funding costs and greater competition for retail bank deposits - will push rates up, albeit gradually.

Mortgage interest rates are already on the rise; key two-year fixed mortgage rates have been edging up slowly over the last year or so, rising from about 5.04 per cent in May last year to 5.27 per cent in April.

While the official cash rate (OCR) is a key driver, particularly for short-term interest rates, a raft of other influences come into play, such as increased bank funding costs, greater competition for deposits, rising interest rates offshore, and higher capital requirements in Australia for the big four banks, who dominate the local banking sector.

Then there is expectation that the Reserve Bank's next move - when it gets around to it - will be an increase, which in itself is putting upward pressure on long-term rates.

The independent NZIER said it expected the Reserve Bank's stance to be broadly unchanged from the previous meeting in May, but with a tightening bias.

NZIER said the economic outlook remained positive and annual inflation lifted to 2.2 per cent for the year to March.

"While higher food and fuel prices have largely driven the recent pick-up in inflation, and may be transitory only, there are also signs that underlying inflation is continuing to lift," said Christina Leung, senior economist at NZIER.

"However, any further lift in inflation is expected to be gradual, and downside risks remain due to heightened geopolitical risks from offshore," Leung said.

NZIER expected the Reserve Bank to begin lifting the OCR from the middle of 2018.

Moody's has downgraded the credit ratings of the big four Australian-based banks and their New Zealand offshoots, which will put slight upward pressure on their funding costs as they seek to raise money offshore. Those higher costs are likely to be passed on to borrowers, Leung said.

Another factor is the US Federal Reserve, which last week raised its fed funds rate - the key driver of world interest rates - to a 1.00 to 1.25 per cent range. Market expectations are that the Fed will move again before the year is out.

ASB chief economist Nick Tuffley expected domestic interest rates to grind slowly higher, aside from the Reserve Bank's actions.

"Those external factors are the ones that have been having a fair bit of influence over the term rates," Tuffley said.

"We have already seen [a] fair chunk of interest rate rises since last year, so we may see them hold for a while, but it is clear that over time the term mortgage rates will go up," he said. "The other big influence is the role of overseas interest rates," he said.

"We do expect the Fed to be fairly cautious but it is pretty clear that interest rates will continue to grind up in the US, and that will flow through and have an impact on our interest rates as well."

NZIER's Leung said higher capital requirements demanded by the regulators in Australia would have an impact on bank funding costs.

On the domestic scene, lending growth is outpacing deposit growth, which is putting upward pressure on deposit rates, she said.

"There is also a growing conviction that the next move [from the Reserve Bank] will be a lift, which has itself already flowed through into long-term interest rates," she said.

In its most recent statement, issued in May, the Reserve Bank took a neutral stance.
"Monetary policy will remain accommodative for a considerable period," the bank said at the time. "Numerous uncertainties remain and policy may need to adjust accordingly."

Today's announcement is due at 9 am.