Banks jumped the gun this week by cutting fixed mortgage rates in anticipation that the Reserve Bank of New Zealand will cut the official cash rate (OCR) by as much as 0.5 per cent this Thursday.
ANZ moved first on Tuesday, cutting most of its fixed mortgage rates and those of its subsidiary, National Bank. ANZ cut its one-year mortgage rate by 0.5 per cent to 5.95 per cent, but left its floating rate unchanged at 6.20 per cent.
This dragged ANZ's one-year rate below its floating rate for the first time since November 2009. All the main banks followed on Thursday.
They were responding to a fundamental shift in New Zealand's economic outlook and a slump in wholesale interest rates in the wake of the Christchurch earthquake.
Banks tend to fund their fixed mortgage rates from wholesale markets for money. These are known as swap rates. The one-year swap rate fell from 3.37 per cent the day before the earthquake to 2.92 per cent on Friday.
Wholesale markets moved in anticipation that the Reserve Bank will stop increasing interest rates this year and maybe even cut them next week when it releases its March quarter monetary policy statement. Markets are now betting that a 0.25 per cent cut is a sure thing and there's a better than 50 per cent chance of a 0.5 per cent cut.
This is surprising given there is significant uncertainty about a cut. Economists from BNZ, NZIER and JP Morgan have said an interest rate cut may be a blunt tool and targeted government spending would be the best way to boost the Christchurch economy.
Research on what the United States Federal Reserve should have done after Hurricane Katrina found the Fed would have been better off raising interest rates to contain inflationary pressures.
There are already reports of prices of petrol, construction goods and groceries rising in and around Christchurch. Commercial rents in some areas have doubled.
This week the NZ dollar also fell to its lowest level against the Australian dollar since 1985, and is down to its lowest level in almost a year on a trade-weighted index basis. This will increase the price of imported goods, adding to the inflationary impact of the oil price surge.
Wholesale rates could rebound if banks are disappointed by a Reserve Bank decision to leave rates on hold. But should those who have chosen to float over the past year jump back into a fixed mortgage? The safest option is to wait for the Reserve Bank's decision.
If, as is now expected, the Reserve Bank does not lift the OCR then a floating borrower loses little and retains the flexibility to ride the rates lower in future.
Bernard Hickey: Rate cuts based on OCR wager
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