Peak interest rates and the long road ahead

Roger Beaumont

Published in KPMG’s Financial Institutions Performance Survey March 2023 Quarterly Results

With interest rates rising sharply to combat inflation and the cost of living, combined with severe flooding and cyclone damage in the North Island, the first half of 2023 has been eventful to say the least. While some commentators are saying the cost of borrowing appears to have peaked, what lies in store for consumers in the second half of the year, and how are banks helping?

In October 2021 the Official Cash Rate (OCR) started rising from its historic low of 0.25% to its current setting at 5.5%, with a sharp increase of 3.5% over the last year. The Reserve Bank of New Zealand (RBNZ) meant to make an impact on inflation by targeting consumption and there are signs it has done exactly that. The tricky part is getting the balance right – not going too hard or too soft. Initially RBNZ was aiming for a shallow recession to slow down spending and rein in inflation. At the recent Budget, the Treasury announced that it no longer saw New Zealand heading into a recession, with growth of 1% forecast for the next 12 months. That’s good news from a macro-economic perspective.

That doesn’t mean households are having an easy time. If you consider around a third of households have a home loan, the sharp rise in the cost of borrowing will have a huge impact. And because New Zealanders generally prefer fixed interest rate loans to floating interest rate loans, RBNZ’s efforts to dampen demand in the economy might take a while to filter through. While the OCR may have peaked at 5.5%, the question now is how long it will stay there. RBNZ has indicated that it will stay at the current level for the ’foreseeable future. Some commentators see it staying at the current peak for at least a year before slowly starting to taper down. That makes sense because it will take some time for the full impact of the raised OCR to take effect. It’s fair to say there’s likely more mortgage pain to come, especially when you consider around half of fixed interest rate home loans will come up for renewal within the next year.

Our six-monthly data insights to December 2022 show that many people with home loans had prepared well for the current financial storm. At that stage 45% of home loan customers were ahead on their loan repayments. They likely retained their repayments at the same as they had been before interest rates hit historic lows, which helped repay their loans faster and save on the overall cost of the loan. It also meant that nearly half of the people with home loans had built in a buffer that effectively cushioned the impact of higher interest rates, which we’re now seeing. It was a double win for them.

As well as mortgagors helping themselves, banks have been there to support customers doing it tough. Banks will work with customers experiencing financial difficulty to find a way through on a case-by-case basis. Depending on the circumstances involved, options may include temporarily moving to interest-only repayments or restructuring the loan over a longer term to reduce regular repayment amounts.

In addition to helping customers through the current economic conditions, banks have also shown they can step up in an emergency. When the floods and cyclone hit the North Island, the banks responded quickly as events unfolded, making $1.4 billion available in low-cost lending, and donating $6.5 million to disaster relief funds. They also provided loan repayment relief and allowed customers to break term deposits without costs. They also worked with RBNZ to get cash to impacted areas.

The banks know that they also have a part to play in helping communities recover over the longer term following the devastating impact of these events. Banks will work constructively with the government, insurers, and other parties to help get affected customers back on track.

New Zealanders are well served by their banks, and that will continue to be the case as we navigate the current economic headwinds. Our banks are well capitalised and regulated, and profitable. That helps make them resilient, which is important at times like this.

Banks also contribute their fair share to New Zealand. Last year banks made a net profit of $7.18 billion. They also spent $9.1 billion running their businesses and paying tax here. That’s a net positive contribution of $1.92 billion – before you take into account the contribution banks make in funding household and business needs, to the tune of around $540 billion.

While interest rates may have peaked, we’ll be living with a higher cost of borrowing for some time yet. The good news is that many people with home loans prepared well for the current economic environment, and our resilient banks are also there to help customers through these challenges.