But the nation's mortgage borrowers relatively more affected by higher rates
Financial systems in advanced economies have so far been largely resilient to risks arising from interest rates, although the full impact is yet to be seen and some areas of concern are emerging, according to the Reserve Bank of New Zealand.
This was according to an excerpt from RBNZ’s upcoming Financial Stability Report, authored by Moritz Mittnacht. The report compared the effects of higher interest rates on financial stability in other advanced economies with developments in New Zealand.
Kerry Watt (pictured above), director of financial stability assessment and strategy, said globally core inflation remains elevated and central banks are expected to keep monetary policy tight for some time.
“Despite challenges caused by rising interest rates, there are few signs of widespread debt-servicing stress in advanced economies,” Watt said. “Non-performing loan ratios remain below levels seen during the Global Financial Crisis and banks’ capital and liquidity positions have risen markedly in all advanced economies since the GFC.”
New Zealand shares many similarities with other advanced economies and compares favourably overall.
“That said, we do have some notable differences in New Zealand,” Watt said. “We are relatively more exposed to higher interest rates because we tend to have higher household debt levels, and our mortgage fixed-rate periods are relatively short compared to some other countries. We are also more exposed to global agricultural markets. But our banks are less exposed to commercial property, our lending standards are relatively tight, and as a country our government debt levels compare well.”
Equity markets still resilient
Although bank stocks fell in the wake of the banking turmoil in the US and Europe earlier this year, equity indices as a whole have performed well and initial concerns of spillovers from financial market volatility that could threaten global financial stability did not materialise.
New Zealand, in particular, saw its equity market initially outperform many other advanced economies during the COVID-19 pandemic. But it has weakened more recently, which may be partly due to the higher weighting of interest-rate sensitive sectors in the NZX50 index compared to overseas indices.
“In the near term, the outlook for global equity prices is likely to depend on how much economic growth slows and how fast inflation declines,” Mittnacht said.
House prices have stabilised
Increased interest rates have pushed up borrowing costs, resulting in a reduced housing demand and a partial reversal of the rapid house price growth seen immediately after the COVID-19 pandemic.
New Zealand, along with Australia and Canada, has experienced the most significant price corrections, due in part to its previous substantial increases in house prices. More recently, house prices in the country stabilised, benefiting from steady interest rates, robust job markets, and a resurgence in migration.
“Future developments in global housing markets may vary, depending on factors such as the extent and duration of monetary tightening, the responsiveness of new housing supply to increased demand, and the share and maturity structure of fixed-rate mortgages,” Mittnacht said.
“The widespread use of mortgages with relatively short-fixed terms speeds up the pass-through of monetary policy tightening to mortgage rates. Downside risks remain if unemployment rises or if financial conditions tighten.”
Headwinds for global commercial property markets
The New Zealand commercial property market, like many others globally, is facing challenging conditions.
“Higher interest rates and lower demand from tenants, caused by more workers choosing to work from home, have lowered asset valuations and worsened property owners’ loan servicing ability,” Mittnacht said. “Funding is also becoming more constrained due to tighter lending standards. In the future, decreasing operating margins for property owners and growing difficulties refinancing loans are likely to raise the share of debt past due for repayment.”
Countries with a higher exposure of the banking sector to commercial property loans tend to face elevated financial stability risks. However, in New Zealand, these risks have been mitigated by stringent lending standards, and as a result, indications of financial strain have remained limited so far.
Kiwi households face higher debt servicing costs
Countries with high household debt relative to disposable income are particularly susceptible to increased default risks when interest rates rise – such as the case seen in New Zealand, where households with shorter-term fixed-rate mortgages are experiencing heightened debt servicing costs, putting strain on household budgets.
“Despite most of mortgage debt having already rolled over to higher interest rates, signs of household stress remain muted in New Zealand,” Mittnacht said. “Financial resilience of households has been bolstered by high employment rates.”
Tightening financial conditions may challenge well-capitalised banks
Over the past year, banks have seen improvements in profitability metrics due to rising interest rates boosting net interest margins. However, in recent quarters, these margins have started to level off in most countries as deposit rates increase and customers move their transaction deposits into term deposits with higher interest rates.
Some economies may experience competitive pressures that drive an increase in average deposit rates, which could negatively impact profitability. Slowing credit growth and an increase in credit losses are also anticipated factors that could further reduce banks' profitability in the future.
“An abrupt tightening of financial conditions or spillover effects from strained sectors, such as the commercial property or household sector, could expose vulnerabilities in banks with an elevated risk profile,” Mittnacht said. “However, stress-tests in most countries indicate that robust profitability in conjunction with ample capital and liquidity buffers would support the banking sector even in case of a material economic downturn.”
New Zealand in strong fiscal position
As central banks raise monetary policy rates, borrowing and debt servicing expenses for governments have also increased, straining fiscal budgets and potentially limiting the capacity for additional fiscal stimulus during a severe economic downturn. The proportion of net interest expenses in relation to total government revenues has increased significantly since the initiation of the monetary policy tightening cycle.
“This is particularly an issue for heavily indebted countries,” Mittnach said. “In comparison to other advanced economies, New Zealand faces relatively low levels of public-sector debt.”
Financial systems resilient to higher rates, but risks remain elevated
In conclusion, RBNZ said financial institutions in major advanced economies show widespread resilience to higher interest rates. Stress indicators remain mostly benign, but some areas are showing signs of stress.
The article, titled An international perspective on the financial stability implications of higher interest rates, is part of the November 2023 Financial Stability Report, which will be released tomorrow.
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