Rate rises bear out predictions

OPINION: You may have noticed that over the past week a new round of increases in fixed home lending rates has kicked off – right after the completion of the previous round, writes Tony Alexander this week.

The likes of our two-year fixed rate are now 7.2 per cent compared with 6.80 per cent a week ago, and 6.5 per cent four weeks ago. This rate was 5.89 per cent in March. Our five-year rate is now 8.75 per cent from 8.6 per cent a week ago, 8.3 per cent four weeks ago, and 6.49 per cent in March.

It was back on March 19, in my weekly overview, that I stated if I were a borrower I would be locking in my rate for as long as possible. Many thanks to those people who have emailed saying thanks for that commentary.

Many thanks also to those kind enough to remember the limb one went out on in the middle of last year, suggesting anyone looking to make a canny housing purchase do so before the middle of this year, given the factors expected to limit price declines then start prices rising again. Prices are now on average 8 per cent up from January and only 3 per cent below the late-2007 peak.

But back to interest rates. Rates have risen largely because the cost to banks of borrowing money has risen. Those increases have been driven partly by the tightening of monetary policy in Australia two weeks ago, which has increased expectations of tightening in New Zealand.

But, also, we have had stronger than expected data released in here in recent weeks. Average house prices rose by 1.9 per cent in September, retail sales rose 1.2 per cent in August, confidence surveys have shot to record levels, and inflation is 0.5 per cent higher than thought. That is, before the numbers came out last week, the common expectation was that annual inflation would fall from 1.9 per cent to 1.2 per cent. Instead it only declined to 1.7 per cent.

It all adds up to our Reserve Bank being highly likely to have to raise the official cash rate well before the "latter part of 2010", which it has repeatedly indicated.

The markets are mainly expecting a rise in January. But we think they will wait a bit longer – perhaps to the middle of the year at the very latest.

The RB clearly wants to do its bit to alleviate business cashflow problems by keeping floating interest rates as low as possible for as long as possible.

In addition, there will be significant restraint on our economy's growth and inflation over the next two years from the exchange rate.

For borrowers, the situation after the latest rate rises – in fact even before them – is that there is little point in doing anything other than floating now.

Our official cash rate forecasts imply that if you float your mortgage over the next two years using the BNZ's Total Money product – which currently has a rate of 5.59 per cent – then your average cost will be 6.5 per cent. That is well below the current two-year fixed rate of 7.2 per cent.

Averaged for the coming 12 months, the floating rate cost will be 5.7 per cent if our forecasts are right and mortgage margins don't change. That is below the current one-year fixed rate of 5.99 per cent.

Basically – if you have not fixed your mortgage interest rate by now there is little point in doing so from a cost minimisation point of view – although clearly one gets some rate certainty.wTony Alexander is chief economist of the BNZ.

» Tony Alexander is the chief economist for the Bank of New Zealand.

- © Fairfax NZ News

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