Two triggers for rate rises

White arrow painted onto road

Back at the start of 2020, the cost to banks of borrowing money to lend at a fixed rate to mortgage customers was about 1.2%. The three-year fixed mortgage rate was about 3.9%. Come November the bank cost of borrowing was 0% and the lending rate was cut to 2.65%.

But since November bank borrowing costs have risen near to 0.6%, yet the three-year mortgage rate offered by most lenders is still 2.65%. Margins for fixed rate lending done by the main lenders in New Zealand have fallen by between 0.5% and 1.1% for the one-year out to five-year fixed terms since around October – November last year.

At some stage banks will raise their fixed lending rates to avoid locking in lending at low margins for a number of years. There are two potential triggers for these rate rises. The first is a generalised shift by borrowers away from the perennially popular one-year period out to three years in particular. The second is a fresh jump up in wholesale borrowing costs.

The monthly survey of mortgage brokers which I run with mortgages.co.nz is telling us that people are shifting away from the one-year term where rates as low as 2.29% can be achieved.

In January 89% of mortgage advisors said that the term most preferred by borrowers was one year

Only 9% said the two-year term was preferred and the remaining 2% were uncertain. Now, in late-April, only 41% of borrowers most prefer fixing for one-year according to the brokers.

Some 22% say the two-year term is most favoured, 12% the three-year term, 6% four years, and 8% five years. At this stage the number of people fixing three years is probably not enough to cause the banks any great angst about locking in low margins. But the direction of change nonetheless is clear.

Wholesale rates are settling down

With regard to the second and seemingly most logical trigger, rises in bank wholesale funding costs, there has been a settling down of rates after some strong increases in February. This reflects some strong statements from central bankers offshore regarding their determined intention to keep their short-term interest rates at current record low levels through to 2024.

In reality, their statements will count for little if the markets decide that inflation rates risk surprising on the high side and that they will be forced to tighten monetary policy early. The debate about inflation is raging internationally. For some the strong stimulus being applied by governments and central banks, along with accelerating rollouts of vaccines and money printing, means big inflation rises lie in waiting.

For others the inflation-suppressing effects of new technologies and international competition will keep price rises to low levels.

In New Zealand we have just learnt that during the March quarter of this year average consumer prices rose by 0.8% to sit 1.5% ahead of a year earlier. Inflation here is still low. It will rise over the rest of this year, but some of the price gains will be one-offs. These include petrol prices because of a shift up in international oil prices, and price rises related to shipping and supply chain problems which will eventually be resolved.

For this year into 2022 it is unlikely that inflation numbers here and overseas will go high enough to elicit any large rises in bank fixed borrowing costs. But the drift in rates is likely to remain upward, especially given the upgrading of forecasts for growth in the likes of China, the United States, the United Kingdom, Australia, and maybe soon Europe.

For borrowers, time is still on their side. But it may pay to recognise the slowly rising risks by distributing one’s mortgage more evenly over periods out to five years rather than just focussing solely on one term. And also, having been an economist writing about the start of monetary policy tightening cycles many times over the past three decades, history tells me that on each occasion (before the GFC) we have underestimated how much interest rates in New Zealand rise. Sometimes we have also under-estimated the speed of increase.

How does this impact me?