Rates Remain Low

Mortgage rates are likely to rise over the next year, but the Reserve Bank of New Zealand (RBNZ)’s decision to hold the official cash rate (OCR) at 3 per cent has kept floating rates down for the time being.

A recent report published by the ASB indicates that the OCR and mortgage rates are expected to rise over 2011, with short-term rates moving the most. With long-term rates staying relatively high, the cost advantage remains with floating or fixing for 1-2 years, the ASB suggests.

The Reserve Bank began removing monetary stimulus in June, lifting the Official Cash Rate (OCR) by 0.25 per cent in both June and July. However, the economic outlook softened somewhat over the subsequent months, and at its September review, the RBNZ did not lift the OCR, preferring to pause at a still-low 3 per cent. The on-hold decision was repeated in October.

The RBNZ forecasts released in September reflect a huge shift in the bank’s view of the recovery and the Bank has revised down its economic growth forecast substantially since June.

In line with this, it has also revised down its projection of underlying inflation.

The ASB report notes that the RBNZ has also reinforced that the OCR is unlikely to climb substantially during the tightening cycle.

Two key reassessments have brought this on: the weak recovery in household demand; and a reassessment of how high the OCR will need to be lifted in the future. The interest rate forecasts are in line with ASB’s view that the OCR will eventually peak at 4.5 per cent.

Despite the downward revisions to growth forecasts, RBNZ do not expect the economy to slip back into recession. Rather, the economy is fragile, and the recovery is more gradual than the experiences following the recessions in the 1990s. 

This is in line with ASB’s expectations of the recovery.

Given the current uncertainties, borrowers need to be aware of the risks to the outlook and conditionality of future OCR moves. ASB expects the OCR will be on hold at 3 per cent at both the December and January meetings, and now see March as the most likely meeting for the RBNZ to resume lifting interest rates.

Importantly, despite the pause from the RBNZ, the bottom line remains the same: further OCR hikes are almost certain, and mortgage rates are set to rise further over the next 12 months.

The ASB expects shorter-term rates to increase the most to reflect these OCR increases, while increases in longer-term rates will be more muted.

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