Fast closing gap between variable, fixed mortgage rates could bolster RBNZ power

  The significantly larger cuts by most banks this week in variable mortgage rates than in fixed mortgage rates raises the interesting prospect that variable mortgage rates could be lower than fixed mortgage rates by the middle of next year. The gap between variable and fixed mortgage rates has wobbled around 150 basis points for most of the period from 2004 to mid 2008 as relatively cheap foreign funding allowed fixed rates that were lower than variable rates. This encouraged home buyers into a love affair with fixed rates that has endured through the last 5 years of the housing boom as interest rates progressively increased. But as the market enters a sustained period of interest rate cuts and the cheap foreign funding has dried up, the prospect of a positive yield curve and lower variable rates than fixed rates is approaching. The average gap between variable and fixed rates has dropped back to closer to 70-80 basis points in the last week. The market player that is completely reliant on domestic retail funding, Kiwibank, now offers a variable rate of 7.95%, which is 67 basis points above its best fixed rate of 7.29% for one year and only 36 basis points above the previous market benchmark at 2 years of 7.59%. The big banks are becoming increasingly reliant on domestic funding also for new lending. Economists are now forecasting the OCR will be cut to 4% or possibly lower in the next six months, raising the potential for a variable rate of 6.5%. The question remains whether longer term wholesale swap rates and the margins above those (which have ranged over 120-180 basis points in recent months) will allow fixed rates to stay below variable rates. Given the disruptions continuing on global markets that looks a remote prospect. This creates the tantalising opportunity for the Reserve Bank to regain its full monetary policy powers, complete with the ability to deliver interest rate moves to the jugular of the consumer economy with a hypodermic needle through variable mortgage rates, rather than through the drip feed to the leg of fixed rates that it has administered over the last 5 years. * This article was first published yesterday in our daily subscription newsletter for the banking and finance industries. The email costs NZ$365 per annum and carries exclusive news and analysis for New Zealand banking and finance industry executives, regulators and investors. Sign up for a free trial here.