Mortgage rates are going up

Mortgage rates are going up

Piggy bank with coins on table

On Wednesday 18 August the Reserve Bank will review the record low 0.25% official cash rate set in place back in March 2020 when we were heading into the economic and health unknown. Worries about a sustained deep downturn in response to Covid-19’s health effects and the direct effects of the lockdown encouraged the Reserve Bank to slash the cash rate 0.75%.

The NZ economy shrank 11% in the June quarter. But it then bounced back ahead 14% and is now bigger than before lockdown. Importantly, while the unemployment rate did rise from the pre-Covid 4%, it never reached levels near 10% many had been predicting. In fact the peak rate was 5.2% and now we have recently learnt that it is back at 4%.

We have also learned that inflation has jumped to 3.3%, that there are shortages of many things in the economy including staff, that wages growth has accelerated quite firmly, and that many price increases are in the business pipeline.

There’s no longer a need for interest rates to be so low

The need for record low interest rates ended a long time ago and the Reserve Bank is going to have to play monetary policy catch-up having over-stimulated the New Zealand economy beyond its ability to grow without producing potentially high, sustained, inflation.

The cash rate will rise at least 0.25% at the review but the chances are high it will be taken up 0.5% if not 0.75%. The chances are even greater however that whatever the Reserve Bank does on the day, it will signal more rate rises ahead.

In fact, whereas back in May the Reserve Bank pencilled in 1.5% worth of cash rate rises starting in the second half of next year, they are likely to signal rises adding up to 2% and warn that they will act quickly if they see signs that people are starting to accept high and entrenched inflation for some time.

For borrowers, the period since late-2008 of low and falling interest rates has come to an end.

Already, lenders have increased their mortgage rates to reflect higher borrowing costs. But there is a lot of catching up to do. Consider for instance that at 2.49% the common one-year fixed mortgage rate is unchanged from where it was last November. But the cost to banks of borrowing money to lend fixed for one year has risen by 1%.

It is hard to know if using the term “interest rates shock” is appropriate because we cannot know exactly the pace with which the central bank will raise interest rates and we cannot know how banks will react as their borrowing costs rise.

The lending marketplace in New Zealand is competitive and we are highly likely to see lenders still offering special discounted rates. But they will be higher than what people have become used to.

How does a borrower protect themselves in a rising rates environment?

In the end you can’t escape a sustained rise in rates away from levels put in place only because there were fears of a new Depression. But those who read what I wrote here so many times and fixed for five years at 2.99% will have a lot of time on their hands to get debt levels down and slowly adjust household budgets for higher costs.

Others will have to make some spending adjustments at a far more rapid pace and that could have implications for the sellers of things which young home buyers in particular tend to spend a lot on – such as clothes, furniture, eating and drinking out, and making quick trips offshore. Actually, none of us can do that last one anyway.

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