September 19th, 2024
In the midst of an economic landscape marked by soaring inflation and a tightening labour market, New Zealand's households and businesses are navigating the treacherous waters of higher interest rates.
The Reserve Bank of New Zealand's May 2023 Financial Stability Report sheds light on the challenges faced by borrowers who must adapt to this new reality. As debt servicing costs climb and early signs of stress emerge, the nation's financial system braces itself to support the economy and maintain resilience in the face of potential economic downturns.
New Zealand's monetary policy adjustment
New Zealand's households and businesses are adjusting to higher interest rates, which have been steadily increasing since mid-2021 due to the Reserve Bank of New Zealand's tightened monetary policy in response to a stretched labour market and strong inflation, according to a May 2023 Financial Stability Report by the Reserve Bank of New Zealand. The effective interest rates on mortgage and business lending have risen by 185bps and 400bps respectively since their low points in mid-2021, with the average effective interest rate on mortgages expected to reach 6.1% by the end of the year.
Increased debt servicing costs for households
Debt servicing costs for households have risen significantly from historically low levels during the pandemic, and by the end of the year, the share of disposable income required to service the interest component of mortgage debt is expected to more than double from its recent low of 9% to around 22%. Despite this significant rise, the debt servicing burden is distributed unevenly, with some borrowers seeing far greater rises in their debt servicing costs than others.
Managing debt obligations amidst rising costs
Tyler Smith and Cuong Nguyen, authors of the report, stated that "although increasing debt servicing costs alongside high inflation will constrain mortgaged households' budgets, we expect most borrowers will be able to continue to service their debt obligations without significant stress, given the servicing test buffers that banks have applied when assessing borrowers' loan affordability and the current strength in the labour market."
However, they also noted that households that borrowed during the period of very low interest rates between late 2020 and late 2021 may struggle to meet their repayment obligations as they reprice onto higher rates.
Early signs of debt servicing stress
The report found that indicators of debt servicing stress are beginning to rise, with early-stage arrears increasing in recent months, and rates of non-performing mortgages and the number of mortgagee sales also growing, albeit remaining low compared to the Global Financial Crisis. For businesses, the commercial property and agriculture sectors are relatively more leveraged and thus more exposed to higher debt servicing costs on average.
Support from the financial system
As debt servicing strains increase, the New Zealand financial system remains well-positioned to support the economy, the report concluded. The country's banking system remains resilient to a range of downturn scenarios, demonstrated by the regular stress tests of their solvency and liquidity positions.
