Fixing still in borrowers best interests

Sharon Zollner

In its Housing Market Overview, the bank says, as has been the case for some time, the one-year fixed remains the lowest rate. But even lower rates are unlikely as wholesale interest rates rise and the economy rebounds.

In ANZ’s view, the OCR and wholesale interest rates are unlikely to go lower from here.

“The economy simply doesn’t need it, and if wholesale interest rates aren’t likely to fall, history suggests mortgage rates aren’t either, and we don’t think the RBNZ’s Funding for Lending Programme changes that,” says the bank’s chief economist Sharon Zollner.

The key question for borrowers is: does it make sense to fix for longer? The bank thinks it does. And given the low margin between two and three-year rates, and four and five-year rates respectively, there is merit in adding some three and five-year terms into the mix.

Doing so will cost more. And while the bank thinks there will be plenty of time for those electing the cheaper one-year to be able to re-fix later, adding some longer terms to the mix will increase certainty.

The recent fall in mortgage rates is not that large in a historical context, according to the report. The lowest mortgage rate is about seven percentage points lower than it was in the late 1990s.

A number of structural factors, such as increased supply of funding globally, lower potential economic growth and declining inflation have contributed to this steep decline. Although the more recent approximately one percentage point dip is not that large in a historical context, it has nonetheless had a significant effect in boosting demand for credit and housing.

Changes in interest rates can have a more potent impact in a low-interest-rate environment, says Zollner.

“This is because the future benefits of owning a house accrue more quickly (are “discounted” less), or put another more intuitive way, future returns everywhere else are super low and that makes scarce assets like housing attractive, driving up the price.

“In short, what else are people going to do with their money? When interest rates are low and supply is constrained, house prices tend to increase more rapidly in response to small changes in fundamentals, while also being more volatile and vulnerable to overshoots,” says Zollner. “That’s exactly what we have seen.”

This is likely to have been a key part of the recent speculative dynamic that has been at play, she says.

Increases sooner than later
Mortgage rates are expected to increase at some stage – and those making decisions in the housing market should be mindful of this fact, says Zollner.

Although the OCR remains at 0.25% and the RBNZ has signalled that it expects to keep it there “until it is confident consumer price inflation will be sustained at the 2% per annum target midpoint, and employment is at or above its maximum sustainable level”, longer-term wholesale interest rates have already started to rise.

This reflects:

• higher global interest rates, which in turn have increased on expectations of higher cash rates elsewhere
• expectations that the next move in the OCR will be up, and not down – talk of a negative OCR now a distant memory
• less downward pressure on domestic bond yields from the Large Scale Asset Purchase (LSAP) programme.

The impact of global interest rates has been the most potent factor.

New Zealand long-term interest rates (five years and longer) have always been highly correlated with global interest rates. That’s largely because New Zealand and foreign bonds are substitutes, and there’s a high level of foreign participation in our bond market, says Zollner.

Bond yields – or interest rates – move inversely with the price of the bond. So, as the prices of various countries’ bonds move together, the yields do too.

The local connection to global interest rates is also a reflection of the fact the New Zealand economic cycle is pushed to an extent by the global economic cycle. Right now, global yields are rising as economies overseas recover and the inflation outlook improves.

Gradual move up
Overall, mortgage rate increases are expected to be gradual. Fixing now is cheap – or at least as cheap as it has ever been.

For mortgage borrowers, the increase in debt-servicing costs they face will be more gradual still – thanks to the fact that many people are on a fixed rate entered into some time ago. Also, for many there may be opportunities to re-fix before rates rise.

While discounts, early repayments and switching complicate the picture, Zollner says the bank can estimate the “effective mortgage rate” reasonably accurately. And its analysis shows it is likely to continue to fall this year even if mortgage rates don’t fall any further, or start rising a little. This is mostly because any borrower rolling off a historic fixed or floating rate into a new fixed rate will pay a lower rate. Eventually, the effective mortgage rate will rise, but with a lag.

However, Zollner says the bank cannot accurately predict borrower behaviour.