Harbour Asset Management says bank funding costs are likely to rise over the next one or two years as the Reserve Bank unwinds measures introduced in response to Covid-19.
As cash reduces in the financial system, banks will look to attract alternative sources of funding.
“Therefore, retail interest rates will likely be pressured higher, independent of any changes in the OCR,” Harbour says.
“We think this ought to encourage a more cautious approach from the Reserve Bank and strengthens our view that the OCR is unlikely to reach the 5 per cent peak that markets currently expect,” Harbour’s Asset Management’s fixed income and currency strategist Hamish Pepper said.
The Reserve Bank’s funding for lending scheme - which offers banks cheap funding at the official cash rate - finishes on December 6.
In July, the central bank started to reduce its holdings of Government bonds accumulated under its quantitative easing programme.
This implies a steady reduction in financial system cash that will likely provide upward pressure on retail interest rates.
Together, these programmes have injected almost $60 billion into the system, providing banks with large amounts of deposits.
“This abundance of liquidity has caused retail interest rates to exhibit unusually low spreads to wholesale rates, hence perhaps why term deposit rates have reacted more slowly than mortgage and lending rates to the rising OCR,” he said.
Harbour Asset has forecast the OCR peak to be 4.5 per cent.
“Our argument is that we have an economy that is slowing, led by households and the property market, but also there is a bit of nuance on top of it which is around the withdrawal of liquidity that will be happening as the Reserve Bank continues with their quantitative tightening and when funding for lending expires next month,” Pepper said.
Wholesale interest rates dropped last week in reaction to lower-than-expected US inflation data.
Pepper said the rebound in the New Zealand dollar has also poured cold water on those making an argument for still higher interest rates.
“We feel that the economy - households in particular - are already feeling the effect of tighter monetary conditions just as it stands.
“And there is this dynamic that more borrowers will be exposed to these higher rates over the next year as those fixed mortgage rates roll off.”
BNZ also sees a 4.5 per cent OCR peak.
The bank’s head of research Stephen Toplis said there was a high degree of uncertainty in the economy.
The OCR has rocketed up from 0.25 per cent in August 2021 to 3.5 per cent in October this year.
“Currently the market is pricing in a peak in the OCR approaching 5.25 per cent, but we think the balance of risk is that is lower than that,” he said.
“The key message that we are trying to deliver is that it feels like the wheels are starting to fall off.
“This is at a time when we are really feeling the first parts of the tightening cycle.
“There are bucketloads of people who are going to get a hell of a shock to their income when they come off a mortgage rate of less than 3 per cent and are having to re-fix at 6″.
Toplis said it looked like the market had not fully taken into consideration the lagged impact of the OCR increases that have already taken place.
“At some point it’s really going to hurt - enough that inflation will fall and that the unemployment rate will rise.”
