Pressure builds on interest rates

Experts pick no shift in OCR for now but rise from mid next year

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, with key two-year fixed mortgage rates edging up slowly over the last year or so.

While the official cash rate (OCR) is a key driver, particularly for shortterm interest rates, a raft of other influences come into play, such as increased bank funding costs, greater competition for deposits, rising interest rates overseas, and higher capital requirements in Australia for the big four banks, which 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 pickup 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.”

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

Moody’s Investors Service 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 overseas. 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 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 was outpacing deposit growth, which was putting upward pressure on deposit 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.”