Since writing my last column about interest rates a fortnight ago we have seen more banks cut their three to five year fixed mortgage interest rates. They have also raised their one year rates but cut their two year rates. I described the boost in the two year rate by the first bank to make adjustments three weeks back as simply a margin grab – and now that rate has been well undercut by other banks not taking the same opportunistic approach to rate setting.
Things are in a state of flux at the moment and there are two key areas of uncertainty. First – and this is what occupies the minds of all participants in the wholesale money markets:
How long will it take for central banks to be confident that inflation is under control and that sending an easing signal is safe?
One factor which has pushed wholesale interest rates down since my last column is less-hawkish-than-expected comments from a number of central banks as they raised their overnight cash rates. But the Reserve Bank of Australia has just reacted to a higher-than-expected 7.8% inflation rate by warning of many more rate rises ahead.
And in the United States, the Chairman of the Federal Reserve has said there is still a long way to go in light of the January employment report in the US. Job losses soared by 517,000 rather than the expected 185,000. That implies more inflationary pressure in the US economy than expected.
One day consensus will be reached in the markets then agreed to by central banks that the inflation genie is once again beaten. When that happens we could easily see cuts in fixed lending rates of 0.5% or more. But we are not there yet, and it is impossible to know exactly when that important stage of the cycle will be reached in light of all the many uncertain factors still in play.
The second key area of uncertainty here in New Zealand is this.
When will average Kiwis pull back from embracing the worst case scenario for mortgage rates?
Even with mortgage rates falling in the past three weeks people are still reading stories about rates rising higher. The problem is that those stories – provided the journalist understands the dynamics – relate to floating mortgage rates and not fixed ones.
When a bank lends to you and I at a fixed rate, it borrows in the wholesale markets at a rate fixed for the same time period. Those fixed wholesale rates reflect expectations for where the official cash rate will sit over the relevant 1-5 year time period. Recently expectations have shifted to the OCR falling faster than earlier thought, and that has pushed wholesale fixed rates down. Banks have passed those falls on into their fixed mortgage rates.
But for floating rate lending, banks borrow at a floating rate and the wholesale floating rates they pay are very closely tied to where the official cash rate is now – not where it is expected to lie in the future. Because the current 4.25% rate is expected to go up to 5.25% this is already factored into fixed mortgage rates. But this rise won’t be factored into floating mortgage rates until it happens.
So, floating mortgage rates have probably another percentage point to rise. But as noted here 2-3 months ago, I am 90% confident that the 2-5 year fixed rates have already peaked this cycle.
At some stage average Kiwis will stop mistakenly believing fixed rates have a lot further to rise.
When that happens, buyers will start to return to the housing market. But we are not there yet and we cannot possibly know when this shift in understanding of interest rate determinants will occur – if it happens at all.
So, be prepared for some continuing volatility in fixed mortgage rates in coming months as views about inflation here and offshore go up and down. And be wary of anyone claiming they know when buyers will return to the NZ housing market. That return will need a change in interest rate expectations and no one can forecast accurately when that will happen.
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