Interest rates to rise 3pc by 2012 says economist

House buyers on floating mortgage rates should plan for interest rates to rise about 3 per cent to about 8.6 per cent or higher by early 2012 according to a leading economist.

The Reserve Bank yesterday held official interest rates at 2.5 per cent but said rates would start rising about the middle of the year.

Reserve Bank governor Alan Bollard said that higher bank funding costs would help reduce the size of OCR increases needed in future, but would not be specific about how far rates would eventually rise.

The Reserve Bank suggested the marginal cost of bank funding had risen to about 150 basis points above the OCR, from about 20 to 30 basis points before the financial crisis.

Mortgage and term deposit rates were rising before the expected increase in official cash rates. The Reserve Bank expected house prices to remain flat, after adjusting for inflation for the next few years.

Bank of New Zealand chief economist Tony Alexander said borrowers should expect rates to start rising in June, but "budget for a 3 per cent increase in floating rates from the middle of this year by early 2012".

Borrowers should stick to floating mortgage rates, despite the expectation that they would gradually rise. But in coming months, borrowers should think about moving into a one or two-year fixed term rate, because the average rate should be lower than floating rates over that period.

At present, one-year fixed rates are about 6.25 per cent, well above the lowest floating rates in the market around 5.6 per cent.

Rising floating rates would "restrain" the housing market, which was already clouded in uncertainty because of tax changes to be confirmed in the Government's May Budget.

However, the housing market would be supported by above average net migration and a continued undersupply of new homes. Mr Alexander estimated the country needed about 1900 new homes a month, but was building about 1300.

The shortage will slowly get worse, so house prices were expected to recover in 2011.

Some economists believe net migration would slow and could turn negative as more people leave for Australia's better economy and job prospects.

But that may not balance the shortage of new homes, because many crossing the Tasman were likely to be skilled tradesmen Mr Alexander said. As well, the government's expected tax changes were likely to put off property investors from building new homes. There was likely to be a drought of rental housing and rents would likely rise, he said.

Westpac Bank economist Michael Gordon also expected the Reserve Bank to start lifting rates in June, rising in 25 basis point steps from 2.5 per cent, to 3.75 per cent at the end of the year and eventually getting to 6 per cent by the end of next year.

Floating rates would move in step with the official cash rate.

But there would be slower moves up in six-month to one-year fixed rates, and it would pay to fix at some of those shorter terms, he said.

While there had been a big shift to cheaper floating mortgage rates, he expected a switch back to fixed rates over time as floating rates rose. If people were unhappy with the prospect of floating rates rising 25 basis points every six weeks, they should move to a fixed rate for a year to two years.

Property investors were more sensitive to longer-term interest rates rather than floating rates and the long-term rates had already moved up so they may not change as much in future, Mr Gordon said.

ASB Bank economist Jane Turner said it would not take many increases in the official cash rate to get back to average levels, which would affect household behaviour.

Any rise in the cash rate would hit borrowing costs immediately, so the Reserve Bank would be cautious about how much it lifted rates and how fast.

- © Fairfax NZ News