Fixed mortgage rates to go higher despite flat OCR, say economists

The recent rise in fixed term mortgage rates is likely to continue over time, compounded by the impact of the Reserve Bank of New Zealand's new liquidity policy for banks, ASB economists said today.

Short term mortgage rates are likely to remain low until 2010, although the cost of fixing for one year or more will progressively creep higher, they said.

ASB chief economist Nick Tuffley and economist Chris Tennent-Brown said the Reserve Bank's implied 'low till late 2010? Official Cash Rate policy would provide some anchor for short term mortgage rates, but that further OCR cuts would struggle to push short term rates lower.

"Short-term rates are being dictated by depositors: deposit rates will be as high as is required to provide banks with sufficient funding to maintain lending," Tuffley and Tennent-Brown said.

"Rather than following the OCR down, deposit rates are now significantly higher than the OCR. Consequently, short-term mortgage rates have hit a barrier that further OCR cuts would struggle to push through," they said.

"A further challenge the RBNZ faces is that financial markets are pricing in an earlier start to OCR increases than the RBNZ's words imply.

Market pricing in part reflects the improved global sentiment, including signs that economies are starting to stabilise."

Long term interest rates are rising across the globe as expectations increase that currently low policy rates will have to be lifted as the global economy recovers from its downturn.

Risk appetites have also been recovering, which has seen money flow out of safe-havens such as government bonds, pushing their yields up, the ASB economists said.

"All these factors have dominated attempts by the US Federal Reserve and Bank of England to contain long-term interest rates by purchasing long-term debt securities. NZ long-term interest rates, paid by the Government and banks alike, have been driven up. NZ is competing to get its share of a hotly-contested pool of global savings."

On top of this, the Reserve Bank's new liquidity policy announced at the end of June is not helping keep rates down, they argued. The Reserve Bank's new prudential liquidity policy requires the banks to lengthen the terms of their funding and include more domestic term deposit funding, rather than the 'hot money' on short-term global wholesale markets.

"The policy will encourage banks to put great weight on retail deposits and long-term wholesale funding, at the expense of more fickle short-term wholesale funding," Tuffley and Tennent-Brown said.

"The irony is that, at present, offshore short-term funding is very cheap now that the impact of the financial crisis has moderated. Banks will increasingly rely on the more expensive sources of funds, which will add further pressure to banks' funding costs," they said.

"The focus on reducing exposure to short-term wholesale funding is entirely appropriate, and also what banks have been steadily doing since the financial crisis began 2 years ago. However, with the RBNZ expecting the first stage of the liquidity policy to be met from the end of September, this prudential policy is not making the job of monetary policy any easier. Depositors, however, will continue to benefit from the very vigorous "deposit war"."

"Over the next year term rates are likely to continue trending up, though more noticeably around the 1- and 2-year mark as the day of eventual OCR increases moves closer."

"There is still some chance RBNZ cuts further, though we are in a distinct minority in even raising the possibility. However, the impact of an OCR cut on borrowing rates would likely be modest - we see a cut being more about slowing the upward creep in the NZD and interest rates than about dragging borrowing rates down."

"The September OCR decision will be a watershed. If the RBNZ does in fact cut, it might provide a (probably brief) opportunity to fix. But no action from the RBNZ will be a strong signal that, despite the RBNZ's repeated concerns about the rising NZD and interest rates, it is not prepared to take any action to stem the trend."

"For anybody who is considering fixing their debt but has yet to do so, the next month is a time to think hard about your requirements. The opportunity to fix at relatively low rates has been gradually disappearing month by month."

"It is hard to envisage a scenario in which term rates will become significantly more attractive. But whether it is appropriate to lock in a long-term fixed rate or stick to the cheap rates (i.e. 12 months or less) will depend on your individual priorities. Key amongst those is how much you value the certainty of term rates against the ability in the short term to benefit from very low debt-servicing costs and some degree of flexibility."

INTEREST.CO.NZ