QUANTITATIVE EASING TO END, AND THE OCR TO RISE
Mark Lister, 14 July 2021
The point of ‘peak stimulus’ is behind us, with the Reserve Bank of New Zealand (RBNZ) today announcing it will end its quantitative easing (QE) bond purchase programme this month.
The RBNZ’s policy settings impact mortgage rates and the currency, so it’s fair to say the changes we’re witnessing could have wide ramifications across the economy - for homeowners, exporters and investors alike.
The conclusion of QE opens the door to a potential increase in the Official Cash Rate (OCR), from the record low of 0.25 per cent that has been in place since March 2020.
In May, the RBNZ released a fresh set of projections which pointed to the OCR rising during the second half of 2022. Since then, we’ve seen a string of upbeat economic indicators and further evidence inflationary pressures are increasing.
Heading into today’s announcement all four major banks were predicting the OCR would rise in November, much sooner than RBNZ forecasts implied. Those views were vindicated by the RBNZ today, and its possible we see a move even sooner.
The next opportunity for the RBNZ to consider a change to its policy settings is in mid-August, and an OCR increase at that time is by no means out of the question. In fact, financial markets have already moved to factor is a 50/50 chance of this.
This would take a bit of heat out of the economy, as consumers would have less money to spend and confidence would be dented slightly.
The housing market might finally take a breather as well. The OCR isn’t the be all and end all for mortgage rates, but it is certainly a factor. Some homeowners would feel the pinch from even a small increase in borrowing costs, with many having purchased homes at extremely high prices and at record low interest rates.
The end of QE and a higher OCR also points to a strong currency, with the RBNZ seemingly ahead of the curve compared to its peers. Sooner or later, other central banks will reduce their QE and raise interest rates too, but they might take a bit more time.
For investors, periods of rising interest rates are usually bad news for fixed income and bonds, although that doesn't mean these important assets should be ignored.
In fact, a modest rise in interest rates would bring a silver lining for many conservative New Zealand savers, as reinvestment opportunities would become more attractive.
For sharemarkets, it’s not all bad. Let’s not forget why we’re all talking about the end of QE and a gradual return to more normal monetary policy settings.
Economic growth is buoyant, commodity prices are strong, the labour market is tight and confidence is high. That’s a supportive environment for business, as long as you’re not too dependent on open borders and if you can find staff.
However, share investors should take note, and ensure portfolios include companies that could benefit from the improving economy, as well as those with pricing power.
Without the falling interest rate tailwind, investors can’t simply count on the rising tide of valuations, which means those that can genuinely grow earnings over the next few years could perform best.
There’s no need to get too despondent things are set to gradual return to normal. With the economy in decent shape, it’s hard to argue we need to keep monetary policy settings at emergency levels indefinitely.
We can’t have our cake and eat it too.