I can almost hear all those people sitting on floating or short-term mortgage rates breathing a sigh of relief after today’s official cash rate (OCR) announcement.
The governor of the Reserve Bank, Alan Bollard, decided to leave the OCR unchanged at 2.50% and more importantly he reiterated his line – the line the markets don’t believe – that OCR increases are not likely until the end of next year.
Yes that is sweet comfort in the short term, but the medium to long term looks increasingly unpleasant.
Two comments Bollard made today are well worth noting. One is that he has removed the possibility of further rate cuts. As readers will recall, in his previous statement he made the enticing comment rates could yet be cut further.
If you had that in your planning take it out now – it isn’t going to happen.
The second comment he made is don’t assume these interest rates will stay at these levels forever.
When they rise they will rise quickly and steeply. This is shown in some of the graphs accompanying today’s monetary policy statement.
Also, one of the economists had this to say: “Once the bank is convinced the time is ripe, sizeable interest rate movements can be expected.”
The view developing is that once the central bank starts tightening, it will endeavour to get the cash rate back up to “neutral” as soon as possible.
Accordingly, the Bank’s 90-day bank bill rate track goes from 2.90% in December 2010 to 5% by March 2012.
While this increase may seem scary, when it happens neutral is somewhere around historical averages, not up around 9% or 10%.
What does this mean for borrowers? The key point is that you will need to consider your strategy over the medium to long term and decide who you will manage your interest rates and cost.
Right now this is an opportune time to be using some of the savings from reduced interest payments to reduce your principal. But I suspect not many people are actually doing that.
One thing you must be aware of is being enticed into sweetheart floating rates. Over the years (although not recently) we have seen lenders offering sweetheart “introductory” deals for shorter duration terms.
There is talk that these sorts of lending products will come back into the market.
Like all good things these terms don’t last forever and at some stage you will probably have to roll onto what I call more standard rates.
One thing I think will happen is that there will be a bit of a campaign amongst banks to get your business as we move into spring more fully. However, it won’t be any of these deals where you can win a house or overseas travel or the like.
It will be around rate and shorter-term rates will come down. In the past week ASB has put out an historically low floating rate of 5.75% and this morning TSB Bank dropped its six-month fixed home loan rate from 5.50% to 5.35%. That makes it the lowest rate for this term, just pipping HSBC and Westpac which both sit at 5.39%. The median big bank six month rate is 5.48%.
There will be a battle for business, but not all lenders are likely to play the game. More importantly the battle will shift away from medium fixed term rates (two years being the recent competitive zone) to floating and short-term rates.
Bollard will like that, as it will make the OCR a more effective tool in managing interest rates, compared to the time when the majority of home loans were fixed at two years and outside the direct influence of the OCR.
The situation homeowners are in now is tenuous if they have not already fixed longer term. Banks have made short term and floating rates appealing so as to entice homeowners short.
As the OCR rises in the future, these homeowners will have no safe haven.
The rule around interest rates goes against the grain for many, but is important…”at the top of the interest rate cycle, stay short term (so they have take advantage of lower rates without huge break penalties), and go as long as you can afford to at the bottom of the cycle”.
Banks are very clever in making the lowest rates that appeal to homeowners, but the worst rate to be taking, both at the top of the cycle and at the bottom. Where is the commentary that helps homeowners figure out that banks are playing their own game for their own gain.