Rates quiet from some upward pressure applied

The main piece of news impacting on the market was the retail sales numbers for February which were released late last week. These came in much more strongly than anticipated suggesting that the economy hadn't slowed as much as many pundits had been predicting.

Such a piece of data will help support the Reserve Bank's view that the economy is still strong and that any cuts to its official cash rate are some way out still.

However, some economists note that it is a dangerous game to place too much emphasis on any one piece of data. The key upshot of the retail spending numbers is that there was a slight increase in wholesale interest rates, thus slowing the flow of cuts to key rates, such as the two-year fixed home loan rate and even putting some upward pressure on them.

There is still a divergent view on the question of when will the Reserve Bank start into its easing cycle. Westpac, for one is saying .We continue to believe that the overriding weakness in recent economic data and sentiment will see interest rate cuts around mid-year, and Bank of New Zealand taking a more hawkish view suggesting cuts will not happen until December.

It is forecasting that the cash rate will stay at its current 7.25% until December when it will be cut by 0.25% and all up cuts this cycle at likely to total around 1.5% come 2008.

During the past week there have only been two changes of note. One is to the BNZ's five-year rate which came down slightly at the start of last week and today HSBC has lowered its one and two year rates, bringing them into line with the other banks.

Currently six-month rates start at 7.99% and go all the way up to 9.00%, however the second highest rate, AXA's, is 8.50%. The choice of provider in this term is much smaller than other terms as only around half the market offer six-month rates.

One year rates are in a very similar range to six-month rates, again starting at 7.60%.

In the two-year term the lowest rate on offer is 7.50% from Mortgage Finance, Kiwibank and Bank of New Zealand. The other big banks are sitting at the 7.70-7.75% mark.

Three-year rates have the lowest starting point in the market, being 7.30% from Mortgage Finance and Kiwibank. BNZ, which has pitched itself as the lowest big bank, is 20 basis points higher at 7.50%.

In the five-year term Bank Direct is the lowest with a rate of 7.40%.

Competition likely to keep mortgage war going
New Zealand's big banks may be far from calling a truce in the battle for the largest slice of the local mortgage market, according to accounting firm KPMG.

KPMG's annual survey of financial institutions found that while banks were looking to protect their margins as the economy slowed, intense competition from rivals and mortgage brokers could see the so-called "mortgage war" enter a new phase.

"Pressure on margins is likely to return, particularly as the fixed term mortgages written in 2004 come up for rate-resetting," KPMG deputy chairman Godfrey Boyce said.

Fixed rate mortgages now make up 80% of banks' mortgage books, compared with 60% in 2002. More than half of all major bank lending is for residential mortgages, following the recent property boom.

Boyce said lending growth in the past five years had "more than compensated" for the erosion in interest rate margins.

Overall, New Zealand banks increased their assets by just over 13% in 2005 -- compared with a 6% increase in 2004.

The intense competition is taking a toll on banks' bottom lines, however, with major bank profits growing by a modest 5% on average in the past year.

Boyce said the standout performer was ASB, which has doubled its assets to more than $40 billion and more than doubled its after-tax profit to $400 million in the space of 4-1/2 years, despite reducing its overall interest margin to below 2%.

ANZ National Bank is the country's largest lender, with total assets as at December 31 of $84b, followed by Westpac on $47b and Bank of New Zealand on $46b.

Reserve Bank leaves rates unchanged and rules outs any cuts this year
As expected, Reserve Bank governor Alan Bollard left his official cash rate (OCR) unchanged and ruled out any rate cuts this year.

The OCR is at 7.25% and was last moved from 7% in December.

"It was a classic case of when there's a lot of noise, the best thing a central bank can do is nothing," says Stephen Toplis, an economist at Bank of New Zealand.

While Bollard acknowledged that economic growth has slowed more than he expected, he also said that the fall in the New Zealand dollar and surging oil prices have increased short term inflation pressures.

"These effects are expected to keep annual CPI inflation above 3% for longer than previously projected and risk putting upward pressure on inflation expectations," Bollard said.

Cameron Bagrie, chief economist at ANZ/National Bank, says the statement was hawkish but that he is encouraged by Bollard saying explicitly that he doesn't expect to have to raise rates again this cycle.

"He's prepared to look through the first round effects. The Reserve Bank is prepared to use the flexibility of the monetary policy framework," Bagrie says.

The danger had been that the currency and oil price shocks might have "scared the bejesus out of the Reserve Bank and that they started putting hikes back on the agenda," he says.

Brendan O'Donovan, chief economist at Westpac, says he has to take the statement at face value but that ruling out any rate cuts this year will lead to bad policy.

Waiting until it's evident inflation is on the decline means "a good proportion of forward looking policy is cut off. That means it feed the economic cycle and it makes the booms bigger and the busts steeper," O'Donovan says.

He estimates there's a lag of about two and a half years between currency changes and its effect on inflation.

Home loan rates start rising
Many home buyers are believing that home loan interest rates will start decreasing when the opposite is happening.

The latest ASB Housing Confidence survey, released today says there has been a big change in findings.

It shows that the number of people who expect rate increases is down from 67% to a net 36%.

Those surveyed appear to have quickly interpreted news of the wider economic slowdown, as well as a cooling in the housing market, as a reduced need for higher interest rates, ASB Bank says.

While the Reserve Bank left rates unchanged at its latest official cash rate review last Thursday, it also gave a stern warning and said that no rate cuts are likely this year.

Since the announcement most the banks have increased some of their fixed rate terms by around 20 basis points, and the expectation is that there are further increases to come.

In the two year market, the mainstream banks have put their rates up to either 7.90% or 7.95%. However BNZ is still the lowest offering its Classic loan at 7.60% and Westpac is the only big bank still to move � offering two years at 7.70%.

These increases are the first since price cutting started in January.

Bank of New Zealand, which has led the price war has cut its advertised two-year fixed rate from 8.25% in December to as low as 7.50% in early April. It is currently 7.60%. ASB's two-year fixed rate for mortgages has declined from 8.30% to 7.70%, and today has moved up to 7.90%.

OCR unchanged at 7.25%
The Official Cash Rate (OCR) will remain at 7.25%.

The Official Cash Rate (OCR) will remain at 7.25%.

Reserve Bank Governor Alan Bollard said: "Data since our March Monetary Policy Statement (MPS) indicate that, while the economy has weakened faster than expected, short-term inflation pressures have intensified.

"The anticipated slowdown in domestic demand commenced in the latter part of 2005 and is projected to continue through this year. This will be partly offset by growth in exports and import substitution, reinforced by the recent decline in the exchange rate. Recent economic indicators suggest the economy will continue to grow modestly through 2006.

"Despite the easing in resource pressures, the short-term inflation outlook has worsened. The exchange rate drop will boost import prices. We also expect significant further price rises over coming quarters as a result of the ongoing world oil shock. These effects are expected to keep annual CPI inflation above 3% for longer than previously projected and risk putting upward pressure on inflation expectations.

"Monetary policy remains focussed on ensuring that inflation settles back within the 1-3% target band over the medium term. As we have stated previously, policy will not try to counteract the one-off boost to prices from the exchange rate and oil price shocks. In this regard, we still do not expect to raise interest rates again in this cycle. However, monetary policy must remain vigilant against these price shocks spilling over into inflation expectations, and price and wage-setting behaviour. Given the current outlook, we maintain our March MPS view and continue to see no scope for a cut in the OCR this year."