Global Rate Hikes Push New Zealand's Interest Rates Higher

New Zealand is feeling the ripple effects of soaring US interest rates, which have hit their highest levels in 25 years. These rate hikes are not confined to the US but are resonating globally, pushing up long-term Kiwi interest rates and, consequently, fixed mortgage rates. Wholesale interest rates, particularly those for bonds maturing in more than five years, tend to move in tandem across the world.

Kiwibank economists highlight that while economic fundamentals drive interest rates, the 'term premium', the extra yield investors demand to hold long-term bonds, is a significant factor. They note that bond markets are always wary of 'vigilantes' dumping bonds, which could drive rates higher or force investors to demand greater yields due to default risks, especially in heavily indebted nations.

Another potential factor influencing rates is the surge in AI investment, which may be diverting funds away from government bonds. The close relationship between global and Kiwi interest rates means that when rates rise overseas, New Zealand's rates follow suit, steepening the local yield curve. The difference between New Zealand's two-year and 10-year bond rates has widened from 100 basis points in May to 120 basis points today.

Looking ahead, the US Federal Reserve's higher cash rate and expected further hikes are influencing the Reserve Bank of New Zealand's (RBNZ) rate expectations. Kiwibank notes that the market is pricing in a cash rate of 3.1% by year-end, rising above 4% by December 2027, a projection the bank finds aggressive. Despite this, the Kiwi currency is benefiting from the rate movements, dropping below 56 cents, which boosts export earnings but also complicates inflation and the RBNZ's OCR decisions.