Kiwibank economists believe that fixed mortgage rates have peaked

Fixed mortgage rates have likely peaked, Kiwibank economists say.

In Kiwibank's First View weekly publication, Kiwibank chief economist Jarrod Kerr, senior economist Jeremy Couchman and economist Mary Jo Vergara say both the retail and wholesale interest rates markets are "perfectly priced, for now".

"Financial markets have been volatile, to put it politely," the economists say.

"Interest rates have risen swiftly, and looked to have peaked in June. Expectations for the peak in the RBNZ’s cash rate [the OCR} were ratcheted higher to 4.5% in June, with the pivotal 2-year swap rate hitting a peak of 4.55%. Since then, expectations have come back, with a terminal rate of a little over 4% priced into the Kiwi short-end. The 2-year swap rate is trading just over 4% (at time of writing)."

The OCR is currently at 3.0%, having been raised by 50 basis points at each of the last four reviews.

"The spike in June saw mortgage rates push higher. The retracement lower in July has enabled banks to lower mortgage and business lending rates," the Kiwibank economists say.

"We believe the market is perfectly priced, for now. We expect the 2-year swap rate to trade in a relatively narrow range around 4% for the rest of the year and into 2023. We believe the OCR will eventually be lowered back towards a more neutral setting, with rate cuts in the second half of 2023."

They say the "timing of the unwind" will depend on the global backdrop.

"A global recession would cause a sharp drop in interest rates. Whereas a soft landing would see interest rates ease at a much more modest rate. We’re forecasting a soft landing for the Kiwi economy. But the risks are certainly tilted towards a deeper correction."

But while Kiwibank's economists are seeing interest rates being cut from next year, economists at the ANZ are going in the other direction and have now pushed out their forecast of when the OCR will be cut.

In their NZ Weekly Data Wrap the ANZ economists say that "for some time", they have had interest rate cuts pencilled into their OCR forecast for the second half of 2024, with the OCR easing from a peak of 4% down to 3.5% by the end of their current forecast horizon (Q4 2024).

"That’s been a reflection of the fact that at some point in the next few years, the OCR hikes the RBNZ has delivered should be effective at bringing inflation back to target, allowing them to then cut interest rates back to a more neutral level (ie a level that is neither expansionary nor contractionary for the economy).

"While obviously what 2024 looks like is subject to extreme uncertainty, we’ve now taken those cuts out of our forecast, to make it consistent with our current thinking. We continue to expect the RBNZ to lift the OCR to a peak of 4% by year-end, though we see the risk profile tilted to more. But we no longer expect the RBNZ will be cutting the OCR over the duration of our forecast horizon (barring some miraculous recovery in the supply-side of the economy, or some unforecastable shock hitting the economy)."

The ANZ economists say the reason for their forecast tweak is simple.

"Upon further reflection, we’re increasingly seeing signs that high inflation is becoming embedded in wage- and price-setting behaviours in the economy. In Q2 [the second quarter of the year], private sector wages were up 7.0% [year-on-year], the share of jobs receiving a larger than 5% pay rise hit its highest level since 2008, core inflation measures ranged from 4.8% to 6.1%, non-tradables inflation rose to 6.3%; and inflation expectations remained far too high.

"And that’s not to mention the endless stream of news articles highlighting the much larger wage increases many workers are getting, the difficulty finding those workers, and employees sometimes explicitly demanding inflation compensation in their wages. In the August MPS [Monetary Policy Statement], the RBNZ noted that in their business liaison programme some firms said wage reviews were happening more frequently as well.

"Wage-setting is, in a nutshell, adjusting to a higher-inflation world. While that’s undoubtedly a relief for squeezed household budgets, it’s a headache for the RBNZ."

The ANZ economists say If high inflation expectations are feeding higher wage-setting behaviour, that means a given interest rate is, in practice, less of a constraint on households than previously thought.

"In the economics jargon, it means the 'neutral' OCR is likely creeping higher. The RBNZ’s latest official estimate is that the neutral OCR is 2%, but they’re currently updating their models. In post-August MPS interviews, some members of the Monetary Policy Committee have given a range of 2-3% for their estimate of where neutral is.

"If the neutral rate has increased, it means an even higher OCR than 4% would be on the cards. For example, if the RBNZ lifted their neutral estimate from 2% to 3%, then a 5% OCR would be needed to deliver the same amount of monetary tightening.

"That sounds high, but remember that in the 2000s, the neutral OCR was estimated to be just over 5%. The actual OCR got to 8.25% before the Global Financial Crisis came along.

"To summarise, if neutral is slowly rising, then the OCR needed to deliver the same amount of monetary tightening is also increasing. At the very least, it looks like the OCR will need to be high for longer to ensure that CPI inflation returns to target within an acceptable timeframe. Hence, we’ve removed the 2024 OCR cuts from our forecast. Importantly, this has no implications for our other economic forecasts. Rather, we think the OCR will need to remain in contractionary territory for longer to deliver that same set of projections."