Mortgage rate forecast for 2016

Arrow signs pointing in opposite directions

The official cash rate (OCR) fell this week to 2.25% - it's lowest level since it's introduction in 1999. It is dropping because we have negligible inflation, the dairy sector is in trouble, and our currency is too strong. We’re caught up in a global currency war where governments and reserve banks are trying to competitively devalue their currencies to avoid a recession. We’re all overloaded with debt and as a consequence, growth is stalling. Although the OCR has dropped and could fall further, it would be a mistake to assume that housing mortgage rates will also fall. Bank funding costs have been increasing due to growing uncertainty and concern about the state of the world and how it will impact on banks – particularly in Europe. The following graph shows how credit spreads (risk premiums) have increased over the past few months.    

With credit markets tightening, the Reserve Bank needs to lower the Official Cash Rate just to keep the market in a neutral state. So in theory, banks won't reduce rates as the OCR falls. You can see that already with banks not passing on the full reduction in their floating rates. The 3 year fixed swap rate fell roughly 0.15% immediately after the latest Monetary Policy Statement from the Reserve Bank. The OCR decrease was unexpected by the market. So the recent drop in the swap rates might suggest a bit of wriggle room when it comes to fixed mortgage rates, but not much. It is now conceivable that we could see a 2 and 3 year fixed rate below 4.00% albeit briefly.    

The yield curve is incredibly flat (with only a 0.30% difference between the 1 year fixed rate and the 5 year fixed rate). This suggests that fixed rates are expected to stay at this sort of level for the foreseeable future. From my perspective there is nothing on the horizon that would suggest otherwise. The only thing that could push fixed rates higher is a severe market correction and a corresponding blowout in credit spreads. With fixed rates this low I’m inclined to fix for longer to lock in the benefit now. Bird in the hand. Although fixed rates will stay low they could spike up if banks suffer significant credit losses for example from dairy and related industry exposures. I personally think that inflation is no longer the key consideration. Borrowers face liquidity risk - the kind of risk that arises with a major credit default event like the Global Financial Crisis in 2008-2009.