Why Europe is driving down fixed mortgage rates

TSB grabbed headlines in February when it came out with a 10 year fixed rate of 5.89%.  That is a sensational rate for 10-year money and we’ve been helping a number of investors jump into it.

Regular readers will know we've said for a number of years that interest rates will stay low for longer. But even I've been caught by surprise by this latest round of extremely low rates. Broadly speaking we're in a low rate environment because our huge debt levels has put the brake on spending and lower consumption (aka demand) kills inflation. It's a story based around supply and demand. During the 2000s there was a huge increase in manufacturing capacity in Asia in response to the biggest consumption boom in history.  This spike in consumption was driven by post-war baby boomers as well as historically low interest rates and debt-growth. In New Zealand debt-growth ran at 15% per year during 2002-2006 and we saw mortgage debt grow from $100 billion to $200 billion over the past decade. That's a lot of extra consumption.

But just as we have had manufacturing capacity hit a peak, Baby Boomers are retiring and reducing their consumption. Coming in behind them, Generation X and Y cannot fill the void. They are a smaller generation by number and they are coming through saddled with debt. So, for the foreseeable future we face an over supply of goods (and the raw materials used in their manufacture) and that means softer prices and the risk of deflation.

If you haven't figured it out yet, Reserve Banks break out in a cold sweat at the thought of deflation. The unprecedented response to deflation, has been to print money, lots of it. Then out of left-field, the biggest surprise has been negative interest rates which most economists thought was practically impossible. We are witnessing negative interest rates on sovereign debt in the likes of Switzerland, Denmark, and Germany and it shows a profound lack of confidence in the future of the Eurozone. The catalyst has been the ECB printing money and buying member sovereign debt. Because there is no centralised debt in Europe, the ECB has been buying up a mix of member sovereign bonds.

And that’s the catch. If Europe were to break up then investors wouldn’t want to be left holding Spanish or Greek debt. Relatively speaking they want to hold the debt of creditworthy nations like Germany. But the Germans are running a surplus and not borrowing, and that excess demand has pushed rates below zero. High demand in Europe for creditworthy debt has reduced long-term fixed mortgage rates to new lows.

In January ANZ NZ raised 750 million 7 year covered Eurobonds priced at a 0.66% yield. This has to be hedged back into NZ dollars so the absolute rate is a bit misleading but nonetheless this is very cheap borrowing. However it’s a limited opportunity for cheap money. To maintain stability, the Reserve Bank limits how much offshore money banks can access and domestic deposits remain relatively expensive. I wouldn’t expect to see interest rates fall further without a decrease in the OCR and at this stage that seems unlikely. When it comes to mortgage rates, my view is to take the bird in the hand.  To do anything else is speculation.

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