Three decades of falling interest rates are over

Toy houses on stacks of coins

In 2019 between May and August, the Reserve Bank cut the official cash rate by 0.75% down to 1.0%. The series of reductions was primarily driven by a combination of a collapse in business confidence about the economy, and inflation for the last quarter of 2018 and first quarter of 2019 coming in at just 0.1% for each three month period.

The Reserve Bank then cut the official cash rate by another 0.75% in March last year as we faced into the economic shock of a global pandemic and lockdown of the country’s population and most of its businesses.

From about the September quarter of last year we could see growth returning with surprising strength in not just the housing market but in the labour market as well. Business confidence has soared along with their investment and hiring intentions.

Inflation on the rise

From an economic growth outlook point of view the case was made before the end of last year for the Reserve Bank to start taking away the 0.75% worth of rate cuts undertaken in March. But from an inflation point of view nothing major was appearing on the horizon until recent months when supply chain disruptions and the development of an extreme shortage of labour started producing sharp increases in predictions for inflation both here and overseas.

Over the past few weeks ever since the Reserve Bank in May pencilled in 1.5% worth of official cash rate rises starting in the second half of 2022, we have been receiving more and more news telling us the inflation risks are increasing.

OCR predictions are being brought forward

In the financial markets analysts and investors started pricing in rate rises starting not after the middle of 2022 but in May. Then timing shifted to February. Then November this year. Finally, following the Reserve Bank’s review of monetary policy on July 14 the markets have shifted to the official cash rate being raised from next month.

This rapid shift in the expected timing for higher rates has been reflected in sharp increases in the costs to banks of borrowing money at fixed rates in order to lend it out at fixed rates. Before this Wednesday we had already seen my favourite rate of 2.99% fixed for five years disappear. Now rates are rising again and borrowers can anticipate that as they roll off their largely one-year fixed rates of below 2.5%, they will be faced with a range of rates from higher than that up to 4.5% and perhaps more in a year and a half’s time.

New Zealand has had a period of falling inflation and interest rates for over three decades. That period has now ended and both will be rising. We are not headed back to the bad days of inflation above 10% (or even 5% beyond a short-blip maybe), and mortgage rates are not going back into double figures.

But borrowing costs are going up and borrowers need to chat with their advisor to discuss what to expect over the coming 2-5 years and how best to structure one’s mortgage whilst focussing on reducing debt as quickly as possible.

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