Mortgage Rates | Fasten your seatbelts

Cars driving on a city street

You need to take a macro view of interest rates to work out the future. My view? We are in for a sustained period of relatively low interest rates. There will be some blips and bumps along the way but I see no reason to be locking into longer-term fixed rates. This week’s official cash rate (OCR) announcement is interesting but inconsequential for my longer-term thinking. My view is that Bollard shouldn’t increase the OCR as consumer spending is already anaemic – and we still have the GST rise later this year to push it even lower. Despite business confidence surveys picking up, our economy is still in a very fragile state with a lot more pain yet to come. We have been through the biggest boom of all time and there is no quick fix for our current predicament. Much of our business and productivity is centred on consumption, which will decline as Baby boomers (the biggest consumers of all time) move beyond their spending peak and into retirement. Much of our economic growth has been driven by consumption that is moving into a period of decline. (Evidence of this: weak retail sales figures and Harvey Norman pumping out 50 months interest free!) One of the global experts on this stuff is Harry Dent (www.hsdent.com). Be warned; he has a fairly bleak view on the current global economy.  (His book The Great Depression Ahead is available at Borders and is a valuable read for anyone remotely interested in this sort of stuff.) Why is this important? Last year there was a lot of scaremongering about inflation taking off and interest rates rapidly increasing as governments print more and more money. If however, consumption declines we will end up with the opposite – the possibility of declining prices and deflation. The Reserve Bank is more afraid of deflation than inflation so any hint of this and interest rates will fall (or stay low).

Rest of the world

Let’s face it - Europe is in a mess. The sovereign debt crisis essentially means that Europe's governments need to stop using stimulus measures to help their economies. Budget cuts and other austerity measures will hit consumer demand, destabilise house prices, and we might see another round of banks needing rescue. Europe is in for a very hard landing, which has implications for the rest of the world. Meantime the United States can keep printing money (its deficit equals $13 trillion) as long as the Chinese keep buying US debt, but the Chinese are set to get shafted when the US devalues its currency or forces the yuan to appreciate. What would happen if the Chinese stopped buying US debt? There is a lot to think about on this subject  – let’s just say there are some very big bets being played out. Put simply - the crisis that started two years ago isn’t over. We are entering its second phase, so expect lots more scary headlines over the next 18 months.

New Zealand

New Zealand had it big recession in the early 1990s when we had our shakeout. Most of our productive capacity is orientated towards agriculture and commodities. In my mind, our recession of the early 90s was worse than experienced elsewhere in the world. In a way it was similar to what Greece and Spain are going through today. We had huge public debt and the Government pushed through its own set of austerity measures. Our open economy has made us lean – for some time it has been survival of the fittest. Our exporters are more recession-proof because we export necessities and not “luxury items.” We are also benefiting from strong economic growth in Asia which is set to continue for another 10 to 20 years. Asia will naturally be impacted by what goes on in the West, but it is now focusing on building up its own domestic demand (and has the money to do it) which is great for us. A growing affluent population in Asia will be good for our industries. The world can stop buying computers, flat screen TVs and cars. It cannot stop buying food. The good news for the Reserve Bank is we are going to see a natural reorientation of productivity back towards exports (and earn our way in the world) but not without pain! As is frequently acknowledged we do have high household debt ($180 billion) and this is our Achilles heel. There is no doubt that, like the rest of the West, we have overeaten and our economy needs to burp. The thing to look out for is ongoing weak retail sales feeding through to business, unemployment and property. Over the past 20 years we've seen a massive shift of employment into the retail and services industries. My money is on this reversing. I predict:

  1. Weak retail sales for next 10 years
  2. Strong export growth into Asia
  3. Minimal inflation and possible deflation
  4. Gradual deleveraging of the property market
  5. Low interest rates.

Should I fix or float?

My view is to stick with floating or short-term fixed rates. Keep your mortgage rates as low as possible and focus on repaying debt. Make sure you are repaying your mortgage so that it is paid off in 15 to 18 years. I’d recommend splitting your mortgage into at least two parts so that you have more flexibility when it comes to fixing in part of the loan or keeping part floating so that you can make voluntary repayments. Use a revolving credit or a mortgage that has a redraw facility so that as you repay the mortgage as fast as possible you can build up a savings buffer (have available funds within your mortgage.) Sometimes a good idea can be to focus all of your efforts on repaying a chunk of your home loan. If you think of your mortgage as an elephant - the old adage is to eat it one chunk at a time. Doing it this way can be quite motivational. The most important message is to repay debt and don’t waste money on things we don't need. We need to move away from hire purchase, personal loans and credit cards. Using consumer finance abdicates our responsibility to budget and live within our means. If you have any debt other than your mortgage, then invest your efforts on clearing that as fast as possible and try not to repeat the same mistake again!