What rate is best? Post-OCR rate update

Question mark on blackboard

On March 12, the Reserve Bank decreased the official cash rate (OCR) by 0.50%, from 3.50% to 3.00%. It is a dynamic world out there so we'll keep amending this blog entry as banks respond to the OCR change.

What does it mean?

We have almost reached the bottom of the interest-rate cycle, but that doesn't mean you need to feel compelled to rush in and fix your mortgage. There appears to be a bit of panic out there the past two days with a view that rates will suddenly go up again. This is a ridiculous argument - (1) rates have only just fallen and (2) we are in the middle of a major recession! We are a long way away from the Reserve Bank wanting to tighten the economy by lifting rates. Interest rates (particularly long-term rates) will jump around a bit in response to the market and that means from time to time they may go up. What we are seeing at the moment (a big jump in the five-year fixed rate to 7.50%) is the result of a massive volume of people switching out of variable rates into longer-term fixed rates. The market simply cannot cope with these sudden volumes and rates go up. Supply and demand. It will settle down again in the next few weeks and rates may drift down a bit. If you have your mortgage in floating then over the next six weeks you should start to consider fixing it - even if it is only for a short six-month to two-year term. ANZ has a three-month rate at 5.65% and ASB has 5.50% for six months; both look pretty attractive for those staying with short-term rates. Floating rates are generally higher than short-term fixed rates because banks take higher margins on these products. However there is no rush to "fix" short-term rates and you might want to wait until the April OCR before jumping in.

How low will rates get?

Interestingly bank margins have fattened up over the past month. Forget the "PR" spin that the rate cut had already been passed on! Kiwibank usually leads the rate charge but it is decidedly quiet this time round. Seems Kiwibank is having major capacity/service issues and is not coping with volume growth. Where is a bit of competition when you want it?  In the "absence" of Kiwibank, I suspect the banks are happy to keep higher margins and we might see a cosy oligopoly emerge for a while. Maybe Kiwibank will surge back in the winter once the housing market slows down! I still think we will see a short-term rate with a four in front of it but maybe not until April - it will be too hard for one of the banks to resist! (Short-term rates have started to fall a bit ... not unexpectedly.) We blogged on Interest Rate Strategies back in February and these strategies still hold true. Short-term rates are likely to stay low for the next two years while we fight our way out of recession. They might jump up a bit off their lows but I'm not expecting the Reserve Bank to consistently start "tightening" for at least two years. That means low interest rates for a while. You could consider making the most of low rates and locking in some two- and three-year fixed rates. Long-term rates have reached their lows and if you want or need certainty, then consider locking in now. The only issue will be, in my opinion, a five-year fixed rate is not long enough to get you through this cycle. The risk, as always, is that the five-year term matures near the top of the next interest-rate cycle. That is why if you go for long-term rates, always split your mortgage. The graph above shows that from the last "bottom" we didn't reach the peak again for nine years. Just as importantly – rates didn't systematically start increasing until June 2003; so a five-year rate at this point would have been close to perfect. I believe we are still two or three years away from our equivalent of "June 2003." Locking in long-term rates is a good strategy if interest rates keep you awake at night (but not the only strategy.) My personal preference is to do some shorter-term rates now and then lock in for five years once rates start to consistently increase - by which time the five-year will be around 7.50% or 7.80%. A good strategy should keep you away from rates above 8.00%. The most important thing to take on board is splitting your mortgage into multiple fixed rates so it does not mature all at once. That is the only way to guarantee you don't get your rate selections completely wrong!