With yesterday’s official cash rate announcement it is understandable that everyone is focussed on when the OCR will move.
But for borrowers that’s only part of the equation and it’s necessary to remember how the market works.
In its most basic form, short-term home loan rates, that’s anything out to 18 months or two years at a stretch, are priced off the OCR.
Looking at what the Reserve Bank is saying and trying to guess its moves and the market’s reaction is understandable.
However, longer terms rates, particularly three years or more, are priced off wholesale markets and these are heavily influenced by the United States economy. The news here is good and there is even talk that the US central bank, the Federal Reserve, will remove its economic stimulus package sooner than expected.
The impact of this for Kiwi borrowers is increasing interest rates and that is what we have been seeing for the past month or so.
We have passed the bottom of the cycle and it is now a move upwards. Borrowers understandably are switching from floating rates to longer-term home loan rates.
While two-year fixed rates have historically been a sweet spot for New Zealanders there is evidence that Kiwis are looking to fix rates around the three year mark.
The low point for a three-year rate was just above 5% and the peak around 10%.
It is ANZ’s three-year fixed rate from 2002 when Good Returns started collecting home loan rate data to today. The three-year rate is still below its average. We have plotted it against the OCR too, which shows the correlation between the two is low.
New factors to think about
In this economic cycle there is a new factor that borrowers need to think about. That is the decision by the Reserve Bank to use its new macroprudential tools to try and take the heat out of the housing market.
While the bank has yet to say how it plans to deploy these tools, bankers and borrowers are trying to guess what impact they will have.
One school of thought is that now the Reserve Bank has a new tool it may not have to increase interest rates as much as it did in the past to control the market. That means the peak of this next cycle may be lower than in previous cycles.
That could mean shorter-term rates will behave differently in this tightening cycle
Secondly if banks are restricted in the amount of lending they can do above the 80% LVR mark then there may be two distinct markets with a huge amount of competition for business where there is more than 20% equity in the deal.
Arguably one of the most important things to note at the moment is that banks are being most competitive in and around the one-year fixed rate market.
There is a good reason for this. Once they have locked you into this space borrowers are forced to take higher rates in subsequent years.
With this in mind it is worth considering very carefully longer-term rates.
There isn’t always a lot of certainty with interest rates but one thing which is a pretty safe bet is that they are only going to head one way. We have had the OCR sitting at its historic low point of 2.50% for years now and it will increase.
While longer-term fixed home loan rate increases are coming through almost daily now the days of cheap debt are disappearing. These rates are moving into the 6%-6.50% range. While increasing they are still low by historical standards.
To finish it is worth looking at yesterday’s OCR announcement to see what it means. While it had a consistent message with earlier statements the governor, Graeme Wheeler, made it clear the stimulus will get removed. It has been interpreted this maybe earlier than previously thought.
However it won’t rise this year.
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