So how does Brexit affect New Zealand? Those who point to the fact that the UK is only 4% of the world economy don’t quite get the full picture of how interconnected our world is.
The Brexit vote sparked a classic flight-to-quality in the bond market. The interest rate on a US 10-year government bond fell to an all-time low as thoughts of an imminent US Federal Reserve interest rate hike were put to bed. In the UK, interest rate cuts are on the cards soon as business sentiment is plummeting. It’s also increasingly likely that the European Central Bank will cut its deposit interest rate further into negative territory in an attempt to boost growth in the region.
Brexit and NZ interest rates
Interest rates also fell sharply in New Zealand following the referendum, with the yield on a 10-year government bond falling 22 basis points on the month to 2.34% at month end. Should short-term interest rates fall in Europe, it’s quite likely that a stronger New Zealand dollar will force the Reserve Bank to reduce its Official Cash Rate (OCR) further.
Also, Japanese and European investors faced with negative interest rates at home increasingly see New Zealand as a safe haven and are lapping up our longer-dated bonds, pushing interest rates down. All the shenanigans have certainly shed a positive light on the political stability, strong credit rating and fiscal propriety of New Zealand.
So if New Zealand interest rates stay low, it’s going to make it increasingly difficult for New Zealanders to retire, as they are going to need much larger capital to draw income from.
Brexit and NZ banks
New Zealand banks aren’t immune to Brexit either. They obtain a significant proportion of their funding in offshore wholesale markets, along with their Australian parent banks and other banks around the world. To the extent that the costs in those markets increase as a result of Brexit, local banks will feel the pinch along with everyone else. While we haven’t seen tremendous signs of bank funding costs going up as yet, this is something to watch for if political uncertainty in Europe rises and stresses on the region’s banks increase.
Apart from interest rates and bank funding concerns, there are second order effects of Brexit which impact on New Zealand tourism and our exports (e.g. dairy products). In this regard, there are likely to be negative consequences for New Zealand at the margin, but on their own are unlikely to significantly derail our economy’s progress.
Partially offsetting these dominant global economic drivers of local interest rates is a relatively well-performing New Zealand economy. In addition, house prices are spiking across the country. Although low inflation suggests the pressure is for lower interest rates rather than higher, these factors place a limit on how far and fast the Reserve Bank can cut the OCR.
This article reflects the personal views of the author at the date shown above. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.
Diana Gordon, Portfolio Manager, Fixed Interest at Gareth Morgan Investments
You can read more articles by Diana on the GMI blog.