Lower mortgage rates, or higher bank margins?

Lower mortgage rates, or higher bank margins?

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The Reserve Bank fully met market expectations this week by leaving the official cash rate unchanged at the 5.5% level they took it to back at the end of May. As previously noted in this column, since the end of May there have been upward movements in New Zealand fixed mortgage rates despite the absence of a change in the cash right. These increases have been driven by rises in rates in the United states because of stronger than expected economic data and reduced optimism about the speed with which American monetary policy will be eased over 2024.

Over the past six weeks the economic data surprises out of the United states have for a change been on the positive side

Positive for inflation, that is. Measures of consumer spending have generally been weaker than expected along with some negative surprises for manufacturing production, business investment, the labour market and the housing market.

Confidence has now improved regarding the direction of US monetary policy in 2024. The upshot is that declines in United States medium to long term fixed interest rates have fed through to some declines in bank wholesale borrowing costs here in New Zealand.

For instance, the cost to a New Zealand bank of borrowing money at a fixed rate for two years in order to lend out at a fixed rate for two years has fallen to around 5.2% from 5.7% early in October. This is about the level the rate was at at the end of May. Does this mean the average two year fixed mortgage rate of about 7% is now set to fall back to the 6.5% of May?

I keep track of bank lending margins for the various fixed rate terms and at the moment the margin which banks are earning for two year fixed rate lending is about 0.5% above the average for the past two years.

In theory it looks like scope exists for rates to fall by half a percent in the near future.

But banks have been running relatively low margins for some time now and it is likely that they want to go for as long as possible with above average margins in order to meet their profit targets. This desire for profit recovery will be one of the factors behind the decision by banks not to run any spring mortgage campaigns this year.

Having said that, one bank has made some minor reductions to its fixed interest rates for two years and beyond recently although at the time of writing no other bank had yet followed that move. It is impossible to know when the banks will decide that market share is once again important. Perhaps an element in that will be a surge in property sales.

If that is so then scope for interest rate declines in the next few weeks doesn't look all that good. We can tell from the data provided by REINZ that house sales weakened just ahead of the election. And although we don't have post election sales data in as yet I can tell by looking at the results from my latest monthly survey of residential real estate agents around the country that there is no fresh wave of either investors or first home buyers moving into the housing market.

The chances are now exceedingly strong that we have seen the peaks for mortgage interest rates this cycle

That said, we remain just as uncertain about the speed with which rates will go down and exactly when they will go down now as we did earlier on this year. Taking into account the constraints on New Zealand’s economy next year from weakness in China's economy, a tightening of fiscal policy, falling house construction, and the El Nino weather pattern, the track for interest rates does look to be downward.

For most borrowers this suggests fixing in the shorter terms of two years and below is probably the optimal thing at this point in the interest rate cycle.

At some point it will be worth fixing for four or five years. But maybe we won't reach that point of the interest rate cycle for another two or three years.

Go to www.tonyalexander.nz to subscribe to my free weekly “Tony’s View” for easy-to-understand discussion of wider developments in the NZ economy, plus more on housing markets.

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