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Summary
- An increase in the 10Y NZ Government Bond is indicating higher than expected inflation.
- It is uncertain whether the rise is truly indicative of inflation or simply an anomaly.
- If inflation does rise significantly, households servicing mortgages could become stressed.
- A retail interest rate of 7% is required before a worryingly amount of pressure would be exerted on NZ households.
The yield on the NZ 10Y Government Bond has jumped 21.1 basis points in the past month. The 10Y bonds stood at a yield of 1.068% reflecting an increase from 14 December 2020 noted at 0.939%.
As bond yields are typically tied to inflation (both move in the same direction and within proportion), it is possible that inflation anticipated by the market will be greater than what is predicted by the RBNZ. According to the RBNZ, Inflation in NZ for 2020 was 1.71%, while it is expected to be 0.58% in 2021.
The better-than-expected inflation might be caused by the billions of dollars the government is currently borrowing and spending, and/ or a more organic growth spurt in the NZ economy.
Anomaly or an accurate prediction
Whether the rise in bond yields is an anomaly and will eventually track back down or is truly indicative of a greater than expected inflation in the coming year is currently uncertain. If inflation is higher than expected, the RBNZ will begin looking at ways to keep it within its mandated range of 1-3%.
The increase in bond yields is not incredibly drastic, but if they continue to rise at the rate they currently are, and accurate, then there could be substantial consequences for the NZ economy.
The consequences
In an effort to combat inflation, the RBNZ has the ability to increase the OCR. The flow on effect of this is that the cost to borrow from retail banks increase. This measure reduces the amount of new borrowing, but importantly also affects those that have already borrowed and their ability to continue making repayments. This is particularly true for those servicing home mortgages in one of the most expensive real estate markets in the world.
The household threshold
Analysis conducted by the RBNZ reveals that Auckland based borrowers are more vulnerable to a rise in interest rates than borrowers elsewhere in the country. Albeit a rise in interest rates to 7% (from an average of 4.5% floating presently available) would be required to significantly stress 5% of existing borrowers in Auckland and 3% elsewhere.
Stressed borrowers might be forced to sell up or reduce their spending on other goods and services. A potential default rate of 3-5% is not exceedingly worrying for the country but would generate a ripple effect through the economy as a whole.
Furthermore, a market interest rate of 7% is highly unlikely considering inflation in NZ has been consistently low since 2008 even with government interventions attempting to kickstart organic growth. Low inflation is a global phenomenon experienced by most advanced economies and appears to be a characteristic of the current financial climate.
