Editorial: Interest rates aren’t the problem - debt is the problem

Budgeting services are bracing themselves for an incoming storm of people seeking financial help. Photo /123rf

Editorial

EDITORIAL

We are increasingly seeing stories of people struggling to pay their mortgages as interest rates rise. The focus is invariably on interest rates being too high. But are they really?

Yesterday, the Reserve Bank surprised markets by saying it was done with OCR hikes.

Because expectations for at least one more hike are priced in, mortgage rates shouldn’t have to rise any further from here. In fact, there could be scope to fall slightly.

A standard two-year fixed rate looks to have topped out just below 7 per cent.

A look at interest rates across the past few decades in the Capital Markets report published by the Herald this week found they are still below the long-run average.

As Liam Dann notes in that article, mortgage rates of 7 per cent probably aren’t so shocking to anyone over the age of 50. Twenty years ago, 7 per cent was the special “cheap rate” the Government applied to student loans.

Since the Kiwi dollar was floated in 1985, the wholesale interest rate has averaged 6.74 per cent, according to Trading Economics.

That average is elevated by a significant period of high rates through the mid-1980s when some mortgage rates rose above 20 per cent.

In the years since 1999 when the OCR was created, the average - at 3.84 per cent - is lower than where we are now.

And it is true that rates have moved higher at a historically unprecedented pace.

We have had a record-setting 12 hikes in a row since October 2021 but we were coming off a historically low base at just 0.25 per cent.

The average rate since 1999 has been skewed down by the emergency low settings in the wake of the GFC and again in the pandemic and we got used to those low rates. They started to feel normal and we - collectively - let them guide our financial decision-making. We borrowed and borrowed, pumping up our own housing market.

The retail banks aided and abetted that borrowing frenzy.

Now we have high inflation again and the cure is higher interest rates. We need to restrict the money supply and remove demand from the economy.

The problem isn’t the rates themselves. The problem is the much higher levels of debt. The brutal truth is, if people can’t pay the mortgage with rates between 6 and 7 per cent, then they have too much debt.

Rates will fall again but hopefully not to the levels we became accustomed to across the last decade. Those rates distorted our asset values and delayed an economic reckoning that we must now face.

The pandemic has exaggerated the scale of the rebalancing, but the process was always going to be painful.

In hindsight, the central banks of the world - most notably the powerful US Federal Reserve - should have moved earlier to bring rates back to more sustainable levels after the GFC.

But hindsight is only handy if we use it to avoid repeating the same mistakes.