Mortgage rate forecast - Why they will stay low

Arrow signs pointing in opposite directions

Whilst economists and most commentators are talking up rates I’m going to provide a different perspective. Given the strength of the NZ dollar and our dependence on Australia, I don't see how we can de-couple from what is going on across the Tasman. As I alluded to in my last interest rate update, the world is still messed up and will be for a long while yet. The big issues around an ageing population, high levels of debt, high youth unemployment wont go away. Despite beliefs to the contrary, the Fed Reserve is not the Fairy Godmother. In this post I wont go back over that old ground. We have the same Official Cash Rate as Australia at 2.50% yet our longer-term fixed rates are over 1.00% higher than in Australia. Their rates are at historic lows, whilst our are increasing. Feeling jealous yet? Looking at swap rates (bank funding rates), bank margins are similar; so on the surface banks are making similar profits on both sides of the Tasman.

  Floating 1 Year 2 Year 3 Year
Australia        
Card Mortgage Rate 5.88% 4.95% 5.04% 5.14%
Swap Rate 2.55% 2.55% 2.79% 3.13%
Gross Margin  3.33% 2.41% 2.25% 2.02%
         
New Zealand        
Card Mortgage Rate 5.75% 5.40% 5.95% 6.30%
Swap Rate 2.63% 2.92% 3.47% 3.90%
Gross Margin  3.12% 2.48% 2.48% 2.40%

I don't think we ever saw the 3 year rate get down to 5.14% and that's a carded rate! Australia has some seriously low interest rates at the moment and prices are on the rise there too. Sydney prices are up around 6% this year. If you think Auckland house prices are high, Sydney is a reality check. This total "Do Up" terraced 2 bedroom townhouse on 82 sqm of land sold for $890,000. It is 4km from the CDB in an area equivalent to Sandringham. Jeez someone has signed up for a big project with this one. The big difference in rates comes down to market sentiment and consumer behaviour. NZ swap rates are significantly higher than Australia. In Australia the market is pricing in the potential for further rate falls. This expectation has increased as the Aussie economy weakens and the world comes to realize that “tapering” is the new normal. Australian consumers are expecting lower rates and they do not have the same propensity to rush out and fix. That lower demand for fixed rates will keep their swap rates low. In contrast in New Zealand everyone is talking up rates and consumers are rushing out to fix. When you have billions of mortgages rushing to fix the market cannot cope and swap rates go up. It becomes a self fulfilling prophecy. 

 

Interestingly as swap rates (and mortgage rates) have been increasing, term deposit rates have been declining so its not all one-way traffic. Higher swap rates disguise increasing bank margins.  Our banks are the most profitable in the world, thanks in a big way to our willingness to borrow money to buy houses combined with house price inflation.    

 

Often we'll talk about the influence the US has on long-term interest rates. The difference between NZ and Australia has nothing to do with the US and is all about what’s going on here. Is the NZ economy really that strong? Why is everyone talking rates up? House prices in Australia are also increasing, so why are we any different?

It would be a huge step out of sync for NZ to start increasing interest rates ahead of the rest of the world.

Australia did that during its resources boom and ended up with a currency that hit 1.08 against the US dollar and a two-speed economy where large parts of the economy went into recession. The RBNZ know that knackering our exporters to deal with housing speed wobbles would be counter productive. Unless we want to go 1:1 against the AUD we wont go into a tightening phase of rate increases. That doesn't mean rates wont increase a little. At least one, possibly two, rate increases are already priced into the current rate curve so the RBNZ has a small amount of flexibility. As interest rates have fallen in Australia and ours have gone up, look at how the NZD has taken off. It is not inconceivable that we hit a new record high which will frustrate the RBNZ.

 

The RBNZ has shown it is reluctant to increase rates ahead of our major trading partners, which is why they have invested so much effort in prudential tools. Personally I think the new RBNZ LVR restrictions (and new anti Money-laundering rules) will bite much harder than most commentators think. If they work, and I think they will, it will take the heat out of the Auckland property market. The NZ Herald reports that the new LVR rules have already reduced demand for new builds.  In my earlier post I estimated that the rule changes would reduce above 80% lending by 60%. That will be enough to reduce overall demand by 20%-30% in some parts of Auckland.  More than that it will put a lot more emphasis on registered valuations, and it will increase short term borrowing costs.

In a Nutshell

Consumers will continue to fix, economists will continue to talk up rates, and rates will continue to increase for a while yet. Things will eventually settle down and rates will go no where in a hurry. I think short-term rates offer the best value for money right now. I'd only consider fixing longer-term if your servicing is tight and the thought of rate increases keeps you awake at night.