New Zealand financial markets are currently pricing New Zealand’s Official Cash Rate (OCR) to remain at or near 2.5% for almost three years. However, the Reserve Bank is forecasting the (OCR) to rise to over 4.0% in the next two years. In its statement the RBNZ did present an alternative scenario where the forecast economic downturn in Europe was more severe and spread to other countries. The current market pricing for rates to remain at current levels is consistent with this scenario.
At Milford our base case has been and continues to be that inflation and therefore interest rates will remain low as consumers and governments look to repay debt. However, we remain alert to the risk that the policy of the more pro-growth countries including the United States, China and the UK may at some stage generate inflation which may require interest rates to be raised more quickly. These policy makers recognize that some inflation is good and will over-time reduce some of the excess debt burden with less pain than the sharp contractions in government spending being proposed by the Euro countries.
The other reason for rates to remain low is that borrowing costs of banks and companies has risen due to financial market uncertainty. This is good news for investors who despite the low cash rate can still generate reasonable returns on fixed income investments.