Interest rates are in focus this week as we look to the Monetary Policy Committee (minus anyone who might ever do macro or monetary policy research) OCR decision, and accompanying Monetary Policy Statement on Wednesday.    No one seems to doubt that the Reserve Bank will cut the OCR this week  (on the radio this morning I heard one of the historically most hawkish of the market economists being interviewed – who only a year ago was articulating the case for a higher OCR – and sounding quite relaxed about two more OCR cuts this year), so the real focus will be on the messages the MPC tries to send about what they might do in future if (unlikely event, as ever) things unfold as they expect.   And perhaps on which risks and issues they choose to emphasise.  I wonder if they will acknowledge that their relatively upbeat GDP forecasts earlier in the year relied on a strong acceleration in KiwiBuild –  of which there is little or no sign.

As week succeeds week, interest rates have generally been moving lower. But it is easy to lose sight of just how large the change has been.  I mostly use the Reserve Bank’s tables, and latest spreadsheet covers the period –  only 19 months –  since the start of 2018.    At the start of last year, the New Zealand 10 year government bond rate was 2.77 per cent.  Today, it is about 1.31 per cent.    That fall was almost as large as what we observed in New Zealand over the course of 2008.

10 year interest rate swaps have also fallen very sharply, with yields down 150-160 basis points over the period.

And it isn’t that inflation expectations have been collapsing.  Here are the yields on the three longest maturity New Zealand government inflation indexed bonds.

Over the course of 2008 the then only (8 years remaining) indexed bond dropped only about 40 basis points in yield.

With two (or more) maturity dates, one can back out an implied future short-term rate at some point in the future.  Thus, for example, the Reserve Bank publishes rates for 10 year and 15 year interest rate swaps, which enables one to back out a implied five year rate in 10 years’ time (ie the period between the 10 and 15 year maturities).  At the start of last year, that implied forward rate was 3.89 per cent.  On Thursday (the last date for which the Bank has published numbers), it was 2.42 per cent (and the 10 year swap looks to have fallen another 15 points since then, most of which is likely to be reflected in the implied forward rate).    Something no higher than 2.3 per cent –  allowing for term premia perhaps something nearer 2 per cent – now looks like the best market guess at the long-term future OCR, when all the short-term cyclical factors are stripped away (no one forecasts cyclical factors 10 years plus ahead).

Incidentally, while those New Zealand yields are low by our standards, and have fallen a very long way over the last 18 months or so, they still look quite high by international standards.   Without a Bloomberg terminal (or something comparable) swaps data can be hard to find, but as far as I could tell 5 year forward rates 10 years ahead are still higher than those in Australia, the US (even though they currently have a higher policy rate), the euro area, Japan, Switzerland, Sweden or Norway.     That has been the New Zealand story for decades – our yields are typically higher than those in other advanced countries, for reasons not including commensurately faster productivity growth.  Low as our rates are now, and are expected to be, those gaps to other countries haven’t closed, and aren’t expected to.

We can do the same implied forward exercise using the indexed bonds on issue.    With a 21 year bond and a 16 year bond, we can back an implied 5 year rate in 16 years time: on Friday that would have been about 1.33 per cent down from 2.9 per cent at the start of last year.   That is a huge fall for an implied rate so far in the future.

With the 11 year maturity and the 21 year maturity, we can back out an implied 10 year rate in 11 years time.   That rate is 1.2 per cent.  The roughly comparable rate in the United States (implied 10 year rate in 10 years time) on Friday was 0.66 per cent.  Long-term real interest rates have fallen a long way in New Zealand, but are still well above those in the United States (and the US is a relatively yielding market internationally).

There was interesting, quite stimulating, article in the Financial Times last week on interest rates, headed “Profoundly low interest rates are here to stay“.   I wasn’t fully persuaded by all the author’s arguments (perhaps partly because he didn’t dig deeply into the question of why interest rates are so low in so many countries), but he ended with a couple of very useful points that are often lost sight of. First

…this is not some perverse plot by Fed chair Jay Powell and ECB president Mario Draghi [or Adrian Orr for that matter]  to make life miserable for the world’s savers. The long-run real interest rate balances the desire to save and demand to invest. Central banks are its servants not its masters.

There are structural issues at play that are not adequately understood, perhaps around savings preferences, perhaps around demography, perhaps around productivity potential, perhaps aroud the optimal capital intensity of future production structures, perhaps…..(each of which have different implications).

I’m still sceptical of the idea that rates will remain low for ever: history would appear to be against that proposition

But the FT author’s final point is exactly right, and one too few central banks –  and probably market participants as well –  have heeded enough

it is time to stop waiting for rates to recover and face the world as we find it.

Including the fact that on current technologies, short-term official interest rates cannot be taken much lower in most advanced countries, and can’t even be lowered much in historically high interest rate countries such as New Zealand.