Kiwibank chief economist Jarrod Kerr looks into the 2019 crystal ball

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By Gareth Vaughan

Kiwibank’s chief economist expects to see the New Zealand dollar weaken and the Official Cash Rate (OCR), mortgage rates and deposit rates all rise next year.

Speaking to interest.co.nz in a Double Shot interview Jarrod Kerr said with the US Federal Reserve tightening monetary policy by increasing the Federal Funds Rate, and the Reserve Bank set to leave New Zealand’s OCR at 1.75% for some time yet, the US OCR equivalent is likely to continue rising about the OCR. The Fed increased the Fed Funds Rate by 0.25% to a range of 1.75% to 2% this week, and signalled two more hikes are likely this year.

“So we’ll have a cash rate in the States that’s 50 to 75 basis points above the cash rate here and that’s the first time in a very long time. And I think it will last at least another two years,” said Kerr.

“So when you look at a bond market you start off with the cash rate and then you work out where interest rates are going to be over time. Their [US] 10 year rate is close to 3% whereas ours is a little bit below that. So our entire interest rate curve is below the US and that’s a first.”

“What that meant historically is that the currency should fall versus the US, so the Kiwi [dollar] should come off. But this time around it’s not quite the same. We have a terms of trade that’s at record highs so that’s putting upward pressure on the currency,” Kerr added.

“If the terms of trade was to come off, so import prices were to rise or export prices were to come off, then I think we’ll see the Kiwi dollar depreciate a little more and that’s what we’re forecasting. We think the Kiwi will drop to [US] 67 [cents] next year. Not a big move but we think it’s the right move.”

At the time of writing the NZ dollar was at US69.53c.

Meanwhile, Kerr suggests the Reserve Bank will be comfortable to start “normalising” monetary policy around the middle of next year. This is against a backdrop of rising global interest rates with the Fed hiking and the European Central Bank indicating it’s going to stop buying bonds, and potentially lift interest rates out of negative territory next year.

“So our forecasts are that the two year swap rate, which is key in New Zealand, will do nothing for the next three or four months. But then into 2019 we’ll see that rate move higher. So if you think a two year swap rate is used as a hedge for banks to offer two year mortgage rates, then that’s going to rise next year. As the RBNZ lifts off, as global interest rates rise, on the other side deposit rates will lift as well. So savers will be getting a bit more for their savings but borrowers will be paying a bit more on their loans.

Asked what normal monetary policy looks like these days Kerr said it’s very different to what it was 10 years ago.

“You don’t know what normal is until you’ve gone past it. So we think it’s around 3%. We think. Or it might be higher. It might be around 3.5%. You don’t know until you get there. Things have changed in the post crisis world. But at 1.75% we know it [monetary policy] is accommodative. So we know they [the Reserve Bank] can do 100 basis points, take it up to 2.75%, and we don’t think the economy will collapse,” Kerr said.

“But it will be a very slow process getting there. You don’t want to get there in a couple of meetings and cause damage. It will be a very slow process. We think the RBNZ will be in a position where they can raise rates in the middle of next year. So we can see our cash rate going to 2%, say in August, and then maybe one more [increase] by the end of next year. We don’t think that will spook anyone, it’s priced in the market, and then a very slow push towards 3%. But we think the Fed will get there first so we’ll remain below them for a while which is good. It will keep the pressure off our currency.”

From an economic perspective Kerr said a continued increase in trade restrictions, or a trade war, is a major worry.

“We’re nowhere near that full blown [copy trading ] war today, but there’s a bit of fuel there that can easily ignite and can escalate quite quickly. That would damage Australia and New Zealand because we are heavily export reliant. Our largest trading partner is China so any war that China’s involved in may hurt us. But we’re plugged into an Asian economy which is growing really well, and has a middle class which is growing. That’s the important bit for us. As their incomes grow they buy more stuff out of New Zealand. So I think we’re okay and the tariffs that are being talked about are basically a rounding error in terms of global growth, but it could escalate,” said Kerr.

He also expects wages to increase.

“We think wages are going to rise. We think the stars are aligned in our labour market. We’ve seen the unemployment rate fall, we’re seeing the labour market tighten. Our business customers are coming to us and telling us it’s hard to find the right labour. And then you have quite a substantial increase in the minimum wage coming through over the next four years. So you’ve got an economy which is bumping up against capacity constraints, particularly in construction and tourism, and some other areas.”

“The way you attract people into a labour market is to increase the money and we think that’ll come through. But then again on the other side of that the employers that have to pay that bill are worried about their ability to pass on those costs, or have to wear them with reduced profitability. We think wages are on the rise after years of really disappointing growth, but it might also slow us down,” Kerr said.


*Also see Kerr’s Top 10 on the top 10 risks to the NZ economy. And the Kiwibank economists’ recent report on the NZ economy New Zealand’s outlook is fine and partly cloudy.

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