Banks have recently increased their fixed mortgage rates in response to a jump in the wholesale interest rates at which they themselves borrow. For instance, the cost to a bank of borrowing at a two year fixed rate in order to lend the money out at a fixed rate for two years has gone from 0.7% a year ago to 2.2% at the end of 2021, 3.3% at the end of March, 3.6% mid-May, and now the cost is near 4.2%.
Over the period of time that the bank borrowing cost has gone from 0.7% to 4.2% the average two year fixed mortgage rate has risen from around 2.5% to 5.7%. We can see that unless we see further increases in wholesale borrowing costs, we will probably not see much further rise in the two year fixed mortgage rate.
In fact, for all rates of two years and beyond we are either at or very close to hitting the peaks for these interest rates. The big question is the extent to which wholesale borrowing costs will rise further. In that regard, for borrowers, the news looks good.
It may be that the cash rate currently is only 2%, but the financial markets are pricing in our Reserve Bank taking its official cash rate to a peak of above 4.0%. The Reserve Bank sees the peak at just below 4.0% and most of us economists think the peak will be even lower than that at 3.5%.
Why do we expect the peak to be lower?
Mainly because the very thing which the Reserve Bank wants to see happen from a tightening of monetary policy is already happening. Household spending is being crunched. We can see it in one bank’s quarterly measure of consumer sentiment which just fell to a record low. We can also see it in my monthly Spending Plans Survey.
Whereas in December a net 17% of my survey respondents said they planned spending more over the next 3-6 months, now a net 21% say they intend spending less.
A key thing happening here is that households are not just being affected by rising interest rates.
Only one-third of households have a mortgage. The rest are renting or have paid off their mortgage. But a higher cost of living hits every household and the 6.9% hike in our living costs in the past year compares with a peak rate of increase of 4% the last time monetary policy was on a proper tightening cycle over 2004-08.
The adjustment down in household spending is also being reinforced by the much tougher lending rules introduced late last year bringing the deepest credit crunch in New Zealand since 2008-09. And from early-2023 we will see further reinforcement of economic weakness from potentially sharp declines in home building activity.
After all, in the past year construction costs have risen near 20% and continue to rise while prices for existing houses are falling at an annualised rate of about 15%. The incentive to build rather than buy an existing property (listings stocks already up 80% on a year ago) is shifting radically.
At some stage before the end of this year I expect a consensus to build that developing economic weakness will curtail future monetary policy tightening and that the Reserve Bank will be easing over 2024. When this happens the resulting falls in wholesale interest rates for terms of two years and longer will probably bring some mortgage rate reductions.
It all adds up to just one thing
If I were borrowing at the moment, it would take a lot to convince me to fix my mortgage interest rate for longer than one year. Maybe I would have some at two years, just to spread my risk.
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