ANALYSIS: One of the key messages I’ve been stressing in my writings and presentations since about the middle of last year is that the scope for large falls in mortgage interest rates this cycle will be limited by various factors. It looks like that message is being picked up by many other analysts and commentators now, with an increasing frequency of warnings that after the 0.5% (or 0.25%) cut in the Official Cash Rate later this month, further cuts if any will be minor.
The financial markets have already factored in this outlook to some degree. Over the past seven months, the cost to a bank of borrowing money at a fixed rate for a year to lend to customers has fallen by 2.3%, but the cost to them of borrowing fixed three years has declined by just 1.7%.
In fact, the cost of fixing a bank borrowing rate in the wholesale markets for three years is currently the same as it was in September last year - about 3.5%.
Since September, the main bank one-year fixed mortgage rate has declined by about 0.8% and the three-year rate by 0.2%. We are probably not too far off the likely cyclical lows for the medium to long-term fixed mortgage rates.
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I write “likely” because the level of uncertainty regarding the direction of fixed rates is extreme. We cannot be sure where New Zealand’s rate of productivity growth will go in the next couple of years and that means we can’t be sure how fast the economy is able to grow before inflation starts to pick up to worrying levels.
We can’t be sure how much businesses will take advantage of the expected improvement in growth to rebuild their margins, which are still being crunched by rising costs. My suspicion is there will be substantial margin rebuilding (higher prices).
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We definitely cannot be sure where global inflation is headed, not only for the usual reasons but also because tariffs are being used as a bashing tool by the new US president.
It is important to acknowledge this uncertainty because it means that the chances of any of us forecasters getting our interest rate predictions right are very low. There is little chance realistically that people like myself will accurately pick when the cyclical lows for different interest rates arrive and what those rate levels will be.
This means borrowers should lean more toward fixing mortgage rates for longer rather than taking a punt. After all, banks don’t take punts on interest rates at all outside the walls of their tightly controlled dealing rooms.
Independent economist Tony Alexander: "We definitely cannot be sure where global inflation is headed, not only for the usual reasons but also because tariffs are being used as a bashing tool by the new US president." Photo / Fiona Goodall
Banks recognise the low predictability of NZ interest rates by borrowing at a fixed rate on the day they lend at a fixed rate. They lock in the margin. Kiwi householders do no such thing. Banks know interest rates cannot be predicted. Householders believe they can and that is why almost no one currently is fixing their mortgage rate for longer than two years.
People believe interest rates have further to fall and that they and the people they listen to will recognise when rates have reached their cyclical lows and that is when they will switch to fixing three years or lower. Or, they will ignore folk like me just as 95%-plus of borrowers did over 2020-21 when they continued fixing for one year at 2.29% or thereabouts rather than locking in for five years at 2.99% as some of us said we would do.
At least this time around the risk of rates jumping up sharply is small so perhaps there is more time for people to contemplate their actions than was the case back then.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz