Borrowers should concentrate on managing risk — not rate chasing

Borrowers should concentrate on managing risk — not rate chasing

Dog excitedly chasing tennis ball

Each month I run a number of surveys of people closely associated with the housing market and my most recent survey was of mortgage brokers. I concentrate on asking them about the presence or not of first home buyers and investors in the market but also invite general comments on what they are seeing and insights into how people are choosing to manage their mortgages.

At the moment just over 70% of mortgage brokers say that the term most preferred by borrowers for fixing their interest rate is 18 months. 17% say two years is most preferred and 10% one year. None indicated that people have any interest in fixing for three years or longer.

These preferences make sense when we consider the outlook for inflation and therefore monetary policy

Although the inflation rate is still much too high at 5.6%, it is well down from 7.3% in the first half of 2022. Monthly gauges of prices for some things such as food have been easing recently, inflation rates are surprisingly on the low side offshore, and oil prices are falling away despite concerns about the Middle East.

We can be reasonably confident that inflation will continue to decline and in fact the Reserve Bank forecast that it will be 2.5% come the end of next year. That outlook implies a shift in the stance of monetary policy away from being tight towards being neutral.

But the Reserve Bank, as noted here a fortnight ago, don’t envisage easing monetary policy until the middle of 2025. That seems much too far out, especially consider the market’s pricing of monetary policy easing in the United States from relatively early next year.

At this stage there is no reason for believing that the Reserve Bank will need to actively stimulate the economy with very low interest rates anytime soon. But the chances are good that the official cash rate will be cut before the end of 2024 and even by the middle of next year – all going well.

Uncertainty remains fairly extreme

After all, we are living through a post-pandemic environment and none of us has experience of what usually happens during such time periods. That is why the focus for people’s interest rate risk management needs to be a lot more on managing risk than trying to score the lowest cost of borrowing as possible for the term of one’s mortgage.

We economists have proven repeatedly since 2007 that we no longer have models of our economy which are accurate enough to produce good interest rate forecasts. Too many things are changing in ways we cannot predict, and this was seen in spades during the post-GFC years when inflation kept falling despite the return of good economic growth.

Borrowers should give a tad less emphasis to trying to be clever and pick the bottom of the rates cycle, and more emphasis to spreading the risk of rate changes over time. This can be achieved by fixing over at least two time periods – maybe one half of one’s debt at a one year fixed rate and the other half two years.

What about fixing for six months?

I cannot rule out a scenario involving inflation falling away unusually quickly and the Reserve Bank having to respond with speed by cutting interest rates. But there are limits to how often one wants to be managing interest rate risk and making hedging decisions. Farmers for instance tend to fix their interest rate for as long as they are comfortable with and concentrate their energy on running the farm.

As we go through 2024, we’re going to get a clearer picture of the speed with which inflation falls. But don’t get confident in believing we economists will be able to accurately pick when interest rates next hit their cyclical lows. If I had to pick a year, I’d say 2026. But by then, who knows what new shocks will have come along to affect our economy.

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