Interest rate rises to continue this year

Interest rate rises to continue this year

Dog looking up

Welcome to my first fortnightly column on mortgage rate levels and prospects in New Zealand. Last year my main themes were along the lines of inflation risks rising and mortgage fixed rates going up later in the year to reflect this. I wrote positively about the benefits of fixing five years at 2.99% but noted that we Kiwis generally stick with whatever fixed rate is the lowest.

At the start of 2022 we can see that all fixed interest rates have in fact risen quite firmly. The best five year fixed rate on offer from the group of lenders which I track is now 4.95%, almost 2% up over the past year. The three year rate is now near 4.69% which is also about a 2% rise from 2.65% last January.

These sharp rate rises don’t so much reflect the Reserve Bank raising its official cash rate from 0.25% to 0.75% late last year. They largely reflect universal market expectations that a lot more tightening will be needed, especially in light of the avalanche of positive and inflationary economic data over the second half of last year.

Inflation is up, unemployment is low

The current rate of inflation at 4.9% is almost twice what the Reserve Bank predicted it would be in their May forecasts. The economy is much stronger and near 6% larger than before the pandemic. The unemployment rate is not the 5.2% Treasury were predicting for late-2021 but instead sits at an equal record low of 3.4%.

The markets expect that the official cash rate will probably go to 2.5% in 2023 and the risk is that the change in central bank thinking globally away from inflation simply being “transitory” means a 3% OCR peak is increasingly likely.

As monetary policy gets tightened – with the next rate review scheduled for February 23 – the main move in fixed mortgage rates will occur for the one year term. That rate is currently near 3.65% which is a rise of near 1.4% from 2.29% a year ago. The one year rate is closely tied to where the official cash rate is currently and where it is expected to average over the coming year.

Data from the Reserve Bank and the monthly survey I run of mortgage advisers alongside tells us that borrowers may not have heeded my suggestion to fix five years, but they have strongly shifted away from fixing one year towards fixing two and three years.

For instance, a year ago a gross 89% of advisers said that their clients mainly favoured fixing one year. Only 9% said the preference was two years, none cited three years or five years. Come June the level of support for fixing one year was 30%, two years 39%, three years 30%, and five years 2%.

The latest data from December show only 6% of advisers see one year as the preferred term, 40% say two years, 45% three years, and 4% five years.

Is it possible that the inevitable outbreak of Omicron in New Zealand and disruption to the economy as thousands of people call in sick will derail the economy enough to take away the inflation risk? No. In fact, with supply chains further disrupted both here and overseas, business costs and therefore consumer prices are likely to receive an additional boost.

In the context of an extreme shortage of staff even before Omicron strikes that means extra upward pressure on wages and extra upward pressure on inflation. For borrowers it looks like the only way is up for 2022 into 2023.

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