Post by David Cunningham - Chief Squirrel
For mortgage borrowers, the Reserve Bank’s Official Cash Rate (OCR) announcement on 24th May was a bit of a mixed bag.
Yes, it was another hike – taking us from 5.25% to 5.50% - but it also came with clear assurances from RBNZ Governor Orr that we’d hit the peak. Interest rate increases were done and dusted, now it was just a matter of waiting it out.
It’s a scary thought for most Kiwi.
And, to my mind, it’s also an absolutely ludicrous one. Here’s why.
The below chart shows how the two-year money market interest rate (a.k.a. the "swap rate") has tracked over the last couple of months. Movements in swap rates are the major determinant of where mortgage rates are headed.
Retrieved from interest.co.nz.
The current two-year swap rate, 5.7%, is the highest it’s been since November 2008.
Now, compare that with the OCR, which is sitting lower at 5.50%.
That difference implies that the money markets believe the Reserve Bank hasn’t got inflation under control – and will need to hike the OCR even further, and keep it up, for the next couple of years.
The one-year swap rate is even higher, at just under 6.00% - which would suggest the market thinks we’re in for two more OCR 0.25% hikes in the near-term.
Floating mortgage rates typically move when the OCR moves. The average rate amongst the big banks right now is 8.60%. Two more OCR hikes would take that average to up over 9.00%.
Fixed mortgage rates typically move as swap rates move, and that can happen every business day – so you see banks changing their fixed rates pretty regularly to protect their interest margins.
In the last week, we’ve seen many of the major banks lift one and two-year fixed mortgage rates, partly reflective of a margin grab, and partly attributable to the rise in swap rates.
If swap rates were to hold at current levels, that could see shorter-term fixed mortgage rates rise another 0.1% to 0.2%, to above 7.00%.
The RBNZ’s main objective is to slow the economy down, so it can get inflation back within the target 1% to 3% range – and OCR hikes are the best tool it has at its disposal (albeit an extremely blunt one) to achieve this.
Remember, we’ve already had 12 OCR hikes since October 2021, from 0.25% to 5.50%. That’s a total of 5.25%.
Now, over 90% of mortgages in New Zealand are on fixed-term rates. That means the flow-through of those increases can take several years, depending on how long you’ve fixed your mortgage for before OCR hikes start.
The below graph shows how “carded” mortgage rates (i.e. advertised bank rates) have moved over the last seven years, compared to the average rates households are actually paying.
The current average mortgage rate households are paying is 5.10% (the blue line).
Already, that average is up massively from a low of 2.8% in September 2021 – and it’s headed to 6.8% (the orange line) if wholesale interest rates stay near current levels. So, mortgage rates for households have risen by 2.3% so far, with another 1.7% to go (on average).
In other words, only 60% of the impact higher mortgage rates has been felt so far. There’s another 40% to go.
Households are already having to tighten their belts to cope with higher mortgage payments, and they’ll need to tighten them much more.
So, there’s a world of pain still to come – and the impact on our economy will grow with it.
Let’s take a look at the facts:
So, have the money markets got it right? If they have, then mortgage rates are headed higher.
But the facts seem to suggest the opposite.
I suspect that wholesale interest rates are currently way too high – and will drop by at least 0.25% over the coming weeks, meaning mortgage rates should be at their peak right now.
And looking ahead to next year, once it’s clear the Reserve Bank has inflation under control, the OCR will gradually be reduced to a 3% to 4% range with a corresponding fall in mortgage rates to follow.
Let’s see what happens.
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