Floating mortgage rates now look more attractive than fixed following RBNZ rate comments, Westpac says in about turn from March

Floating mortgage rates are now more attractive than fixed rates after the Reserve Bank's dovish comments in its monetary policy outlook yesterday, Westpac chief economist Dominick Stephens says.

The pick comes less than two months after Stephens touted two to four year fixed rates as looking the best bet for borrowers, when he said rising wholesale swap rates could see fixed rates stop falling, and begin to rise.

His comments back in March sparked debate among a number of bank economists, with ANZ chief economist Cameron Bagrie saying the 'hoop-la' about fixing looked at odds with the Reserve Bank's assessment of where rates were headed. See Stephens outline his latest views in this video here.

Reserve Bank Governor Alan Bollard yesterday delivered a relatively dovish statement on where the Official Cash Rate (OCR) might be headed as he kept it on hold at its record low of 2.5%.

The comment from Bollard that got economists most excited was aimed at the high New Zealand dollar, which the Reserve Bank said had remained elevated despite falling commodity prices.

"Should the exchange rate remain strong without anything else changing, the Bank would need to reassess the outlook for monetary policy settings," Bollard said.

In its March Monetary Policy Statement, the Reserve Bank indicated it was pricing in only 75 basis points of OCR hikes over the next three years. Economists and the market read Bollard's comment yesterday on the outlook for monetary policy settings as flattening that view, and that there was an outside chance the next move in the OCR might be down.

Wholesale, or swap, rates fell on the comments, although the currency immediately rose. Kiwibank quickly moved to introduce a new "special, limited time" one-year home loan interest rate of 4.99%, under cutting the rates advertised by its rival banks.

Change of mind

In his weekly video on Friday morning, Stephens said the Westpac team now saw floating rates as better value to borrowers than fixed, a turn-around from March. He said the Reserve Bank yesterday made no mention whatsoever about raising the OCR, whereas it had included such a reference in its March statement.

“What they seem to be saying now is, the most likely scenario is interest rates will be kept unchanged, but there is a possibility the next move could be in a downwards direction," Stephens said.

It wasn’t the domestic economy or inflation that was concerning the Reserve Bank, rather it was that the exchange rate remained strong despite signs of weakness in the global economy and falling commodity prices.

“The Reserve Bank’s telling us that if the exchange rate stays high and commodity prices keep falling, exporters could face a double-whammy, there could be downward pressure on inflation, and they may need to reduce the OCR," Stephens said.

In Westpac’s opinion, cutting the OCR at this stage would not be the right thing for the Reserve Bank to do.

“We think it could stoke the housing market, and that with the Canterbury rebuild coming, there is some inflation pressure ahead for this economy. We continue to expect higher interest rates over 2013/14/15," Stephens said.

“Now a couple of months ago we flagged that we thought two-year to four-year mortgage rates were better value than floating. At the time, wholesale interest rates had risen quite sharply, and there’d been no response on retail mortgage rates," he said.

“The situation’s really changed. Recently, wholesale interest rates have been falling, and with this week’s OCR review, they’ve fallen further.

“Floating mortgage rates now look like better value, at least for now, than fixed," he said.

What Bollard meant

Bollard's comments on "the outlook for monetary policy settings" related to the Reserve Bank's forecast 90-day bank bill rate track. In its March MPS, the RBNZ forecast the 90-day  rate would rise from 2.8% in the March 2012 quarter to 3.1% in the March 2013 quarter, indicating the OCR would be 25 basis points higher – 2.75% - at this time.

The MPS forecast the 90-day track to then rise to 3.6% by the March 2015 quarter, suggesting an OCR of 3.25% at that time - 75 basis points above its current level.

That outlook would only be reassessed if the New Zealand dollar remained high, and without "anything else changing". The comment on 'anything else' meant just that - it did not mean changes from the Reserve Bank's forecasts.

So if the NZ dollar stayed high and nothing changed, like domestic activity, trading partner activity, or commodity prices, then the Reserve Bank would reassess where it thought rates were headed.

Stephens had warned...

At the time of his fixed rates pick in early March, Stephens said that while the Westpac economics team expected mortgage rates to rise a little over the year, "there is a risk that mortgage rates could stay low for longer than we expect."

"But there is less risk of mortgage rates actually falling materially from here. First of all, the Reserve Bank has flatly indicated that it does not intend to lower the OCR, even if the global economy deteriorates quite seriously. The main scenario in which the Reserve Bank could relent and cut the OCR is a full-blown banking crisis in Europe," Stephens said in March.

"But in that scenario, mortgage rates would not necessarily follow the OCR lower. Global capital markets would probably freeze, making it even more difficult and expensive for New Zealand banks to procure overseas funds. The spread between the OCR and mortgage rates would widen further. Depending on the severity of the crisis, mortgage rates could actually rise rather than fall," he said.

"Given that there are risks, and floating rates are low, why not wait a while longer before fixing? The trouble with that strategy is that others are thinking the same thing.

"If a rush of borrowers all try to fix at the same time, interest rates will be forced up by the surge in demand. Exactly that happened in March and April 2009. There was a rush of borrowers seeking to take advantage of low fixed rates, and only a limited pool of savers/investors willing to commit their savings at such low rates. Market forces quickly saw fixed mortgage rates rise," Stephens said.

"Waiting for the ding-dong low before fixing might make you part of a large crowd all hoping to exit through a small door at the last possible moment. The nimblest few will make it, but most will wish they had exited earlier," he said.

See wholesale rates rise through February, but then the fall from mid-March in the interactive chart below: