Editorial: Brace yourself, interest rate rises just getting started

Home buyers need to be aware that their interest costs will rise. Photo / NZME

EDITORIAL:

Next week the Reserve Bank will almost certainly lift the Official Cash Rate for the second time in a row.

With inflation at nearly 5 per cent and unemployment near record lows at 3.4 per cent it will have little choice but to shift the rate from 0.5 per cent to 0.75.

Some economists argue the bank should go harder and deliver a double hike - taking the rate to 1 per cent.

Either way, there can be no doubt that interest rates are now well and truly on the rise.

Banks have already started moving on expectations of further rises.

By some measures, their mortgage rates are rising at the fastest pace in 15 years.

Two-year fixed-term mortgage rates now sit between 4.15 per cent and 4.35 per cent, compared to 2.5 per cent six months ago.

But it's important for New Zealanders to remember that the price we pay to borrow money is still low by historic standards.

What we are experiencing is a return to some kind of normal for interest rates.

If we look back across the past 20 years or so, normal means mortgage rates north of around 7 per cent.

If we look back 40 years, then the average is even higher.

If inflation were to become entrenched for a long period as it did in the 1980s then mortgage rates could head well north of 10 per cent, in theory at least.

There's historic precedent for that. The two-year fixed mortgage rate was approaching 10 per cent as recently as 2007 - just before the GFC.

The Reserve Bank had pushed the Official Cash Rate up to 8.25 per cent to try and get on top of inflation, which was nudging 5 per cent a year.

That's also about where inflation is right now.

But in reality rates aren't likely to go that high for the simple reason that we can't afford them too.

We have too much debt. Skyrocketing house-price growth in the past decade has pushed mortgages to levels that make double-digit interest rates unthinkable.

That doesn't mean the increases of the next few months won't hurt.

When we become accustomed to a certain price any increase will bite.

And percentages are cruel.

An additional 3 per cent on a $400,000 mortgage in 2007 meant finding an extra $780 a month.

In 2021 an additional 3 per cent on an $800,000 mortgage would require finding $1360 more a month.

In some respects this gives the Reserve Bank more leverage.

Reserve Bank Governor Adrian Orr is expected to lift the OCR again next week. Photo / Mark Mitchell

It doesn't have to hike as far to see its policy start to have an impact.

Bank economists are picking we'll see the Official Cash Rate keep rising to about 2.5 per cent.

In a relatively upbeat economic outlook this week Westpac forecast we'll see the rate at 3 per cent by the middle of 2023.

Based on current margins that would push mortgage rates back above 6 per cent and normal service for borrowers would have resumed.

With the housing market is still running hot, let's hope borrowers are doing the math and factoring these rises into their equations.