Bernard Hickey: Stick to floating if you still want toast and coffee

The coffee and the toast may well survive the weekend. Photo / The Aucklander

It's quite possible this time next week when you sit down to read this paper with a cup of coffee and toast that you'll be asking yourself whether you can still afford the coffee and toast.

If you have a floating rate mortgage by next Sunday your bank may have increased the rate by 25 basis points to around 5.9 per cent. That will cost anyone with a $200,000 mortgage an extra $10 a week.

That's because the Reserve Bank is widely expected to increase the Official Cash Rate (OCR) from 2.5 per cent to 2.75 per cent this coming Thursday to start withdrawing some of the monetary stimulus being pumped into an economy well into its recovery phase.

Reserve Bank Governor Alan Bollard has rightly described himself as a truck driver who wants to take his foot off the accelerator before the economic truck barrels too quickly into the upcoming corner of higher inflation.

In previous tightening cycles the immediate reaction for anyone still on a floating mortgage would be to jump to a fixed mortgage, often a two-year rate, which was usually cheaper anyway.

But this time it's different. Most two-year mortgage rates are about 7.3 per cent and they are also likely to rise soon after the Reserve Bank puts up the OCR. Anyone jumping to a fixed rate would immediately see their $200,000 mortgage cost them an extra $60 a week.

Despite it being nearly two years since the worst financial meltdown since the Depression, banking has not gone back to normal.

Banks are now unwilling or unable to access the "hot" international money they used to offer New Zealanders cheap fixed interest rates.

Their shareholders aren't keen on such unreliable sources any more and the Reserve Bank is forcing them to raise more of their funding from local and longer-term sources through its Core Funding Ratio regime. This funding is harder and more expensive to get.

This is one reason the Reserve Bank has repeatedly said coming increases in the OCR will be slower and less severe than in the past. The Core Funding Ratio could be called an engine brake.

This means floating mortgage rates are likely to stay lower than fixed rates for some time and any increase in floating rates will not be as severe or as fast as in the past. The coffee and the toast may well survive the weekend.

bernard.hickey@interest.co.nz