If you’re happy and you know it, borrow some cash?

If you’re happy and you know it, borrow some cash?

Global growth continues to edge down amidst an almost farcical global political backdrop. Back home, sentiment has, if anything, darkened in response to the Reserve Bank (RBNZ) 50 basis point OCR cut in August. For property markets, will the allure of low interest rates overcome ingrained caution?

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Gloomy globe
Global growth has continued to slow as 2019 has progressed, and by a small margin, this year is likely to be the slowest since the recovery from the Global Financial Crisis. 2020 is set for a similar below-average performance. China’s manufacturing and export sectors are feeling the heat from the trade tensions with the US, Europe is losing momentum and Germany, usually the region’s powerhouse is flirting with a mild recession. Additionally, the US is likely to decelerate through the impact of the past sustained lifts in interest rates – which are now being reversed – and the waning sugar hit from tax cuts. What is encouraging from New Zealand’s perspective is that our export prices are generally riding high – we are even benefiting from the combination of China’s swine fever outbreak and China’s shutting out of US agricultural products. But slowing tourist arrivals and softer log prices are reminders that we can’t be complacent.

The risk is that the ongoing political backdrop undermines global growth even further. Uncertainty is a challenge decision-makers in businesses naturally have to cope with. But the very arbitrary nature of uncertainty induced by the whims of politicians is much harder to cope with. The hot/cold approach of US President Donald Trump to negotiations with China makes it hard for businesses to see what the end game is. The same goes for UK Prime Minister Boris Johnson’s ‘negotiating’ tactics with the EU and his Parliamentary shenanigans. The prolonged period, with lack of resolution in sight, risks undermining businesses’ hiring and decision-making – and not just in the directly affected countries.

New Zealand caution
Uncertainty – more broadly, a lack of confidence – is also a growing handbrake for New Zealand’s current expansion. New Zealanders are dealing with their dosage of global headlines, which arguably provide a very narrow (and bearish) perspective on the world beyond our borders. There are also a number of domestic factors. Businesses report rising costs and added margin pressure, as well as difficulty finding suitable workers, yet they either can’t or won’t offer higher pay. In addition, the Government’s economic and environmental policy agendas are fuelling business caution.

Business confidence, as measured by surveys, has gone from bad to worse, down to levels usually seen around recessions. And, concerningly, business confidence has fallen even further since the RBNZ’s outsized 50 basis points cut in August. It appears as if businesses have responded to the news along the lines of “what do they know that we don’t?”. That is an unfortunate initial reaction, as the RBNZ’s action was – if anything – aimed at heading off any bad news at the pass, rather than prompting people to dive for the bunker. Further OCR cuts are likely, potentially to 0.5%.

Life isn’t all that bad. New Zealand’s key exports are mainly destined for global households and less exposed to the global slowing in manufacturing activity. The local population is still growing strongly. And ultimately, the marked declines in interest rates to date will improve the cash flows of businesses and the mortgage belt. Economic growth is likely to average upward of 2.5% over the next few years, although it is currently closer to 2%.

But, as recent business and consumer confidence surveys show, people aren’t yet convinced that they should turn the spending taps on. The RBNZ Governor has even gone to the length of exhorting households, businesses and the Government to spend more. The entire point of lowering interest rates is to encourage people to spend now rather than later, and to seek higher investment returns through taking greater risk while – hopefully – supporting investment activities that will improve New Zealand’s productivity.

Property to benefit?
When it comes to the various property markets, the outlook comes down to the drivers of demand through continued population growth and the allure of low interest rates, against people’s perceptions of how the economy, asset prices and job market will perform. Early indications from the housing market (at least) are encouraging. Sales turnover has been lifting off the lows set early in the year and prices are showing greater signs of life, even in the becalmed Auckland market.

What attributes does property hold in this environment? One that investors will be focusing on is the potential yield. The ‘extremely low for a long time’ interest rate backdrop brings two important ingredients. The first is even lower financing costs, although in time added bank capital costs will erode part of the benefit. The second is further reinforcement that what counts for an acceptable yield threshold is going to remain low. Property is likely to benefit from the search for yield, being one of the alternative assets to holding money in cash and other interest bearing assets.

The warning for investors, though, is to make sure they have thoroughly thought through the risks. Property is an illiquid asset, and in times of personal financial plight or market weakness it may be challenging to realise its full value if a sale is necessary. Investment in property will also create an exposure to the underlying industry or sector, an important factor to bear in mind when economic growth is only moderate and numerous vulnerabilities are lurking around. Low interest rates are intended to encourage greater risk-taking, but that doesn’t mean the risks have melted away!

By Nick Tuffley, Chief Economist, ASB Bank


This article featured in NAI Harcourts’ Key Assets magazine issue 3, 2019.
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