14 Mar 2014

Interest rates could rise to 5% by 2017

10:34 am on 14 March 2014

They're off! The Reserve Bank has kicked off the latest interest rate hiking cycle, which, if we're to believe the forecasts, could be as high as 5 percent or more by early 2017.

The Reserve Bank building in Wellington.

The Reserve Bank building in Wellington. Photo: PHOTO NZ

But that's too far off to contemplate, and much can happen in that time.

Back in March 2011 when the official cash rate was cut from 3 to 2.5 percent in response to the devastating earthquake in Canterbury a month earlier, the Reserve Bank expected to remove those reductions before the end of the year. Three years later, it's finally happening.

Borrowers should brace themselves, and quickly. The central bank is signalling further rate increases in April, June and July, taking the official cash rate to 3.5 percent before September's election. Another hike has been thrown in after that for good measure, meaning the cost of borrowing could be 3.75 percent by the end of the year.

The retail banks aren't waiting around. ANZ lifted its floating rates within a few hours of the announcement, and the others are expected to follow quick smart.

Of course, it's good news for savers, who outnumber those on mortgages. While banks have tended to be a little slower putting up deposit rates, ANZ did lift those rates on Thursday as well.

Is the Reserve Bank in danger of stalling the fast-growing economy?

It doesn't think so. It's forecasting the creation of 105,000 jobs and unemployment to fall to about 5 percent next year, fed mainly by the rebuilding of Canterbury, construction in Auckland and dairy boom.

Governor Graeme Wheeler worries that not getting on top of inflation early is the real killer of economic growth, because authorities have to react heavily, hiking interest rates sharply causing output to fall and unemployment to rise.

But there's definitely a sense of uncertainty in this latest cycle.

No major central bank is close to raising interest rates, leaving New Zealand standing alone as a beacon for global currency investors. The high dollar has already risen even higher, hurting exporters even further.

The central bank is also unsure how households and firms will react. With threequarters of households on floating mortgages or fixed rates of less than one year, a succession of rate hikes could make its presence felt quite quickly. But it's been a long time since people have had to react to higher interest rates, and that was before the global financial crisis.

Will they react as predicted?

The likely path of rate increases is never smooth. If higher rates constrain households and firms spending plans quickly, then rates may not rise as high as signalled. If not, it could be a very painful time for the New Zealand economy.

Only time will tell.