By Gareth Kiernan*
Since late 2022, we’ve been predicting that mortgage rates would peak at over 7% this year based on our outlook for wholesale interest rates. But since the start of 2023, mortgage rates have generally tracked sideways or downward. Why are financial markets seemingly resistant to the Reserve Bank’s efforts to quell inflation by weakening demand through tighter monetary conditions?
How do we forecast mortgage rates?
The foundations of all our interest rate forecasts are two key rates: the official cash rate (OCR) and 10-year government bond rate. The OCR reflects expectations of policy decisions the Reserve Bank will take to meet its mandate, which is primarily to keep inflation between 1% and 3%pa, and the OCR is highly correlated with wholesale 90-day bank bill rates.
The connection between the OCR and 10-year bond rates is more nuanced. In theory, bond rates reflect expectations of short-term interest rates over the life of the bond. But there are times when OCR increases can lead to lower long-term bond rates, if financial markets believe the Reserve Bank is overdoing its tightening now and will need to cut the OCR further in future, for example. And with trends in international bond rates also having a bearing on New Zealand’s bond rates, our bond rate forecasts have a high degree of independence from our OCR forecasts.
Our fixed mortgage rate forecasts are a weighted average of the 90-day and 10-year rates outlined above with an additional “premium” built in for the retail margin. Our estimate of the premium is reasonably dynamic and based on recent market trends, which we allow to revert towards a longer-term historical average over time. We also recalibrate the model’s weightings of 90-day and 10-year rates for each fixed mortgage rate from time to time.
We have looked back at our modelling over the last 16 years and pulled out five representative sets of 90-day and 10-year weightings for fixed mortgage rates. In Chart 1, we have plotted the two-year mortgage rate against the highest and lowest modelled two-year rates. The trends for the two-year rate are mirrored across other fixed mortgage terms.
The need to align the maturity profiles of funding and lending
Prior to 2009, two-year mortgage rates usually tracked around the bottom of the range in Chart 1. The catalyst for a shift around 2009, which broadly coincided with the Global Financial Crisis, was a change in macroprudential requirements from the Reserve Bank that required lenders to match up the maturities of their lending books with their wholesale funding. Previously, for example, banks had been able to offer a two-year mortgage rate based on their “bets” of where wholesale rates would go over the term of the mortgage.
So, if Bank A thought the Reserve Bank was going to cut the OCR by more than financial markets were expecting, it could take a gamble to try and increase its market share and offer a lower two-year mortgage rate than Bank B, whose pricing would be more in line with two-year wholesale rates. If Bank A’s forecasts were correct, it could instead roll over short-term wholesale funding throughout the two-year mortgage term and maintain its profit margins as the OCR fell by more than markets had been expecting. If Bank A’s forecasts were wrong, its margins would be squeezed.
Even before the Global Financial Crisis threw much of the world’s banking system into turmoil, the Reserve Bank had adjudged that the risk of these bets going wrong and causing significant bank losses was too great – hence the change in requirements outlined above. The subsequent alignment of banks’ funding and lending maturity profiles appears to have added about a percentage point to the “premium” for the retail margin. As a result, the two-year fixed rate has tended towards the top of our forecast range between 2009 and 2020.
The temporary deviation from this trend in 2020/21 is likely to have been caused by the provision of cheap funding through the Reserve Bank’s Funding for Lending Programme. But the deviation since the start of this year has no such obvious cause. If anything, we would have expected the gradual introduction of increased capital holding requirements by the Reserve Bank (a change that was postponed due to COVID-19) might be starting to drive another step increase in the “premium” built into banks’ lending rates.
Swaps and discounting not the whole story either
Banks typically use swaps to convert short-term funding to longer-term funding to align with their lending maturity profile. These wholesale swap rates move closely, but not exactly in tandem, with government bond rates. Since about November last year, swap rates have trended lower than bond rates, implying that banks have experienced less upward pressure (or, in the case of five-year rates, more downward pressure) than government bond rates have otherwise suggested.
Although swap rate movements might offer some explanation for mortgage rate trends this year, it’s not an entirely compelling one. The current gaps between swap rates and bond rates are not particularly different to their long-term averages, so the fact the gaps have shrunk over the last six months doesn’t explain why fixed mortgage rates have broken away from the top end of our modelling range.
There has also been evidence of some mortgage rate discounting taking place by banks this year as they chase market share. Exactly why banks would be falling over themselves to lend money on an asset class that is declining in value is unclear, but when turnover in the housing market has almost halved over the last two years, lending targets imposed by sales managers will have become increasingly difficult to meet. February saw BNZ offering a “secret” 4.99% one-year rate, with less aggressive specials of 6.19% for 18 months and 5.99% for three years also appearing over the last few months.
But even these selected examples fail to explain the divergence of fixed mortgage rates from our modelled trend shown in Chart 1, which is repeated across all fixed mortgage terms. Discounting of a specific fixed mortgage rate to attract more borrowers would only show up for that selected lending term, rather than across all fixed rates.
Don’t fix long at the peak
Back to the original question: much of the above discussion is moot considering last week’s Monetary Policy Statement, where the Reserve Bank signalled that the OCR has probably reached its peak. The lift in wholesale interest rates following the government’s expansionary Budget was reversed out by the Bank’s Statement, and financial markets are now firmly thinking about when the Reserve Bank could start to cut the OCR. Although the Bank’s own forecasts suggest a cut might not occur until the second half of next year, longer-term wholesale rates are likely to gradually factor more cuts into their pricing – particularly if headline inflation continues to track downwards as forecast.
Perhaps the most important lesson to remember is the one learnt by borrowers in 1998 and 2008: jumping on long-term rates because they’re the lowest currently on offer can come with significant costs later. In April 1998, five-year fixed rates were at 9.4%, compared with one-year rates of 10.0% – but by April 1999, one-year rates had plunged to 6.1%, so being locked into that 9.4% for another four years was eye-watering. Similarly in April 2008, five-year rates were 9.5% and one-year rates were 10.7%, but the latter had dropped to 5.8% a year later. With five-year rates currently sitting at around 6.4%, the potential for regret now is nowhere near as large. But if this is the peak in mortgage rates, it might the last point in time you want to be fixing your mortgage for too long.
The information provided is of a general nature and is not intended to be personalised financial advice. You should seek appropriate personalised financial advice from a qualified Authorised Financial Adviser to suit your individual circumstances.
*Gareth Kiernan is chief forecaster at Infometrics. The original article is here.
78 Comments
Recent FHB's watching house values fall now have to navigate shark infested waters by somehow choosing the right fixed term (one that will inflict the least financial harm). Its hard to imagine how these events make home ownership a positive life changing experience. No doubt someone will be along here shortly to argue that somehow it does....
FHB's were first sold an overpriced lie, now they're being fleeced by banks.
"No doubt someone will be along here shortly to argue that somehow it does…."
Or maybe not, maybe the vast majority of left leaning, envious property hating rentiers are getting successful in ousting commenters with different views, so that they can turn the comments section into an echo chamber of self congratulating, upticking, negative, property loathing people without having to deal with anyone who has a different opinion.
"ousting commenters with different views"
I thought that this was what you did by complaining to the moderators?
"envious property hating rentiers"
Not this card again! I have no envy for those who have made a lot of money out of property. Actually I feel sorry for them. 'Never has so much been given to so few for doing so little'. Its the opposite of Churchills Battle of Britan speech when I think of property investors in this country. They are our nations anti-heroes.
I envy them in spades. There was a game and it had defined rules e.g. taxation, council regulations. It was pretty simple, if you wanted to play, and it is purely optional then you could make money and gain some potential advantages. Maybe the rules and nature of the game has changed and it is up to participants to either step out or find a new sport.
How many of the whiners who demonize property investors have made gains through substantial investment in shares/ETFS and such like? Few. Most sit on their asses and whine.
Disclaimer-my 2 rentals largely paid for my family home, and now the share portfolio is worth marginally more than our house. I still drive a Honda Jazz 2002 with 199750km on the clock and spent several years working part time in a motel whilst having a stressful 40hr week job.
Bet most of the renters here drive nicer cars than me. Wear brand name sunglasses and eat regularly in cafes. Oh 'they deserve it.'
Maybe the rules and nature of the game has changed and it is up to participants to either step out or find a new sport.
Yeah, but the 'game' is "securing stable housing for you and your family." It's not exactly one you can opt out of. The only two available options for most people are 'pay too much for a rental' or 'pay too much to buy a house.'
Yes, somewhere in the post WWII era, we turned a human right into a game of winners and losers, moving away from socialisms (such as effective social housing) and towards privatization/capitalism. Wanting for nothing has nothing to do with it. For those who made off with squillions, zero envy. Not my thing. But for them to be winners of the game, somebody else has to lose. And those losers were simply making a choice as to which option would provide the least loss; pay ever inflating rents, or make a jump and hope for inflation.
It's easy to say they made a bad decision buying at the peak, but consider a FHB couple in their 30s, likely paying 30-40k in rent per year. What is the loss value here. The risks were either pay more and more rent, or have some glimmer of hope for financial freedom. What an unfortunate game.
A human right is for shelter not a three bedroom ensuite house with garage. Also look at lifestyle choices. I never smoked haven't drunk alcohol for 40 yrs don't eat out never touched drugs. Usually worked 45 plus hrs a week in a job (when I had a job) and then worked either my own business or on the farm I brought. Most young people of today think they are busy taking photos of themselves trying to be a influencer
You're not wrong. I am technically a millennial and feel that my generation was the last generation to know life pre-social media, broadband internet when there were less distractions, temptations, essentially life-noise. Gen Z have huge potential, they have so many different areas they can work in in the digital age compared to 20years ago. The issue is as you say Colin, there is a lot of showmanship pushed via social media exposure and pop culture which makes it harder to keep their eyes on the ball on average (there are plenty of financially literate folk in Gen Z as well).
Historically the world has always wound up with a physical conflict that rocks the world economy and causes countries to fall on hard times, which teaches everyone a lesson in terms of risk, and results in a greater level of prudence. It has been a long time since the share market crash of '87, and many now grow up not understanding what a hard time looks like. In time, people will keep whining but reality will one day cause most to reflect and realised that their goals can never be achieved without sacrifice, planning and will power.
"Ah, the mythical left-leaning, property-hating rentiers, banding together to create echo chambers of self-congratulating negativity. But fear not, dear writer, they're no match for the power of reason and open dialogue. Keep searching for balance and genuine insights, because assumptions alone won't change the world." - ChatGPT, 2023.
Personally I'm quite disappointed to see so many old bulls disappearing from this site. A discussion where the only participants share the same view isn't much of a discussion. A shame to see from the reactions to your comment that many do not feel the same way.
I think the quality of the discussion on this site could be improved by a daily comment limit. The usual suspects can fill the breakfast briefing with comments about how they wish the world was, and then discussion can be freed up for how the world actually is.
I suspect if you asked homeowners who have owned their own home for 5+ years -- if owning their own home is a life changing experience -- you will get a different answer to asking FHB's in year 1 or 2 especially in a falling market or rising interest rates. The fact is that owning your own home is not just about today -- its about 30 years time -- its about not having a one year tenancy or being asked to move house when your 72 -- its about not having a mortgage or rent when you retire - its about being able to invest and change your property to meet your needs and desires - not asking permission to paint a room or hang up a picture
Like many things in life -- the journey can be hard to start with but usually gets much easier in time -- Home ownership was never easy -- and thats unlikely to change in the next 50 years -- its a sacrifice now for longer term gains
Where to from here - either interest costs go higher or our ability to afford accommodation costs (disposable income after tax and housing) reduces.
Until we get to a point where all policy arrangements in this nation aren't tipped away from favouring our housing market and towards more productive means, mass exodus of talent might continue and an increasing majority of those who come in are "economic refugees".
Aussie is not an exception to these issues either, but economic opportunities are far fewer here in NZ for those not able to engage in housing speculation.
Michelle Marquardt, ABS head of prices statistics, said: “It’s important to note that a significant contributor to the increase in the annual movement in April was automotive fuel. The halving of the fuel excise tax in April 2022, which was fully unwound in October 2022, is impacting the annual movement for April 2023.”
Something we still have to look forward to here in NZ.
IO, I suspect Yvil has aspirations of filling HW2's shoes. Some people struggle with the reality that interest.co.nz membership consists of a random cross section of society. From an investment perspective, property is now out of favour as the figures far from stack up. That's precisely why the vested have run for the hills.
Like you ousted yourself RP, when a few years ago you couldn't bear to see interest rates drop and you were repeatedly wrong about these rates rising and property prices falling. Now, several years later, you're back !
And yes, from an investment perspective, property is now out of favour as the figures far from stack up, and property investors are taking a bath.
You know I am IO, I have made my views quite clear multiple times that I believe NZ is heading for hard times. That's why I believe that interest rates will be dropped towards the end of this year (a prediction I made in October 2022). Not that inflation will be back below 3% by then, but when times get tough, central banks will accept higher inflation in order to try to save the economy.
Yvil was forecasting a depression five years ago......
by Yvil | Fri, 04/05/2018 - 13:36 "So be brave and let the great depression happen. It's much better than the long slow downward spiral we're on now, which will still lead to a depression"
Enough to make one reach for the pills!
What a wonderful comment! Thanks for posting it RP! But instead of letting the downturn run its cycle 5 years ago, governments and central banks did exactly the opposite, dropping interest rates and QE. Just imagine what better position we would all be in today, if they did what I proposed.
Indeed.
Orr's comment that the recent increase takes us to the previously expected peak is likely to prove to be nothing more than politically motivated weasel wording in support of his buddy Robertson.
Just about every indicator is that inflation is not controlled and in fact multiple factors point to increasing inflation - Govt spending in the budget, climate change clean up actions, increased immigration numbers, the upcoming fuel tax re-imposition...
There's literally nothing pointing the other way, and yet Orr decimates the NZ $ with his wording - the only possible reasoning for which would be to support the Govt's stance that their spending was not inflationary.
The numbers will tell the story, but it will become increasingly untenable for the RBNZ not to raise the OCR further this year - per a another article on here, they may be hoping to leave that until after the election - but I sincerely doubt they will have that luxury.
Mortgage interest rates more higher or lower. Good question.
But first question what needs to be asked in NZ is what is the average value of land and houses we need in this country. It's very high and people are committed to years of banks slavery already.
So increase in rates will create more pain for current mortgage holders but it might bring sanity to the land and house prices in the long run.
The rates going lower will create that piranha insanity in the market again and make it more unbalanced.
Cameron Murray in Aussie is interested in how consumer price indexes (CPIs) differ between countries. He says Total housing weights (OOH and renters) in CPI are also very different. For ex,
AUS = 22%
UK = 31%
NZ = 28%
US = 42%
CAN = 30%
EU = 12%
Interesting read.
https://www.fresheconomicthinking.com/p/mysteries-of-inflation-measurem…
Rabbit holed and found this also interesting read
I'm interested in your view, what should FHB do? I suspect many are priced out/waiting. But those with means and intending to buy, what should they do? Or rather, what would you do?
My view, if it were me, I'd wait it out. Let it drop and miss the bottom entirely and let it rise. Once my own "real" price against my own income was nearing flatline, look to buy. I suspect rates wouldn't be inverted then, so split the mortgage between 1yr, 3yr and floating with the intention of offsetting against a strict savings account, weekly deposits making up to the level I was stress tested at.
Hi malamah, "if it were me, I'd wait it out. Let it drop and miss the bottom entirely and let it rise. Once my own "real" price against my own income was nearing flatline, look to buy" I think your view is very good, I would do the same! Just be careful to not postpone forever. What I mean is that there is always some reasons not to buy, if you look hard enough. Buying a house is not only about finance, it's also very much about emotion and courage. Good luck to you.
Well that's the question, I believe we're close to it, as I replied to IO above, I have been forecasting a drop in interest rates by the end of 2023 (prediction made in October 2022).
As a personal commitment with my own $ on the line, I have fixed my mortgage for 3 years at 2.89% in August 2021, so we shall see if I made a good call to expect lower interest rates by August 2024...
It has been widely agreed upon that higher interest rates will correlate with lower house prices (which would be better for the long term prospects for our society)… But, for what reasons may we be wrong?
Could large immigration numbers prevent house prices dropping further?
What about low unemployment and boomers retiring en masse?
Can anyone comment on these questions, or think of any other reasons why prices may not end up dropping?
If we somehow find a productivity miracle that allows wages to rise without causing high inflation would be the only way I can see. And we would need to suddenly transition to an exporting power house so we reverse our current account deficit (but who is going to buy our exports if the rest of the world is in bad shape? China doesn't look good). As you can see, we are currently in serious trouble: New Zealand Current Account - 2023 Data - 2024 Forecast - 1971-2022 Historical (tradingeconomics.com)
As it stands, if we have high inflation it is because we aren't producing enough (i.e. there is excess demand for goods and services) which will result in RBNZ destroying that aggregate demand via ever higher interest rates (and then lower property prices).
So I think house prices are either going to fall in nominal terms, or inflation adjusted terms. E.g. they could go flat while inflation stays at 5% for a few years and allows debt to income ratios to return to more manageable levels for interest rates that are 5% or more. But that could see prices still fall another 20% or so in inflation adjusted terms.
If we have falling interest rates it is because we are in a deflationary bust (which is quite possible) but that will mean companies go under, people lose wages and jobs, and there will be mortgagee sales as people default on their debt (as it would take years for the lower mortgage rates to flow through to mortgage holders. e.g. if fixed on 1-5 year terms). If this eventuates, house prices could fall much more in nominal terms.
I can’t see any reason right now why they won’t keep falling. Assuming interest rates stay about the same for the next 6 months, I think prices will need to fall another 5-7% before demand starts to reignite in any meaningful way. Something has to shift - either interest rates or prices - and it won’t be interest rates, save a black swan (see below)
I think we might stop seeing median prices fall soon. This is because the number of relatively cheaper newer build townhouses being sold will start slowing, so the composition of sales will shift more towards bigger, older and higher priced homes. But the HPI will keep falling.
While immigration might push up rents a bit it’s unlikely to have a significant impact on house prices.
So the only chance I see that prices will stop falling over the balance of 2023 is a black swan event. A major international economic event, which leads to big rate cuts, or a major international incident such as a big terrorist incident in Australia or the UK which scares a whole lot of kiwis to return home en masse (like in the early 2000’s)
My expectation is a variant of this - broadly similar interest rates (actually rising a bit, but not hyperbolic) but the force that hurts asset prices will be continued tightening of credit by lenders terrified of seeing the wheels detach. A sort of "Oh yeah rates aren't doing much, but who cares, the credit hoses have stopped anyway except to a few rich people".
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