Fixed home-loan rates look likely to increase

By BRIAN FALLOW, Economics editor

Fixed mortgage rates are set to rise after a steep increase in United States bond yields last week pushed up the cost to banks of funding them.

As floating mortgage rates fell to a new benchmark of 6.7 per cent after Reserve Bank Governor Don Brash cut the official cash rate for the fifth time this year, a sell-off in the US bond market pushed up the cost of the longer-term wholesale money banks use to fund fixed-rate loans.

"We think we have now seen the lows for fixed-interest rates and retail borrowers should strongly consider fixing, preferably for terms of two to four years," said Bank of New Zealand chief economist Tony Alexander.

Fixed-rate mortgages account for 45 per cent of home loans by number but 58 per cent by value, Reserve bank data show.

Yields on US 10-year bonds rose sharply from 4.3 per cent at the start of last week to 4.85 per cent by the end.

That reflected increased confidence in a rebound in the US economy in the middle of next year.

As usual, higher US rates flowed through to the New Zealand market where 10-year bond yields climbed from 6.04 per cent to 6.4 per cent over the week.

More to the point, the swap rates at which banks borrow to fund fixed-rate loans also rose over the week. The one-year swap rate rose from 4.82 per cent to 5.09 per cent and the three-year rate from 5.58 per cent to 6 per cent.

"Given that our three-year fixed housing rate of 6.75 per cent was set when the swap rate was about 5.7 per cent, the rise to 6 per cent suggests that, subject to market competition, the rate may rise about 0.3 per cent shortly," Mr Alexander said.

ASB Bank economist Anthony Byett also expects the rise in wholesale rates last week to flow through to retail lending rates, but thinks beyond that rates are likely to go nowhere for two or three months.

"The US appears a long way from having to tighten cash rates," he said. "For the next few months a choppy sideways trend is the most likely scenario for US and New Zealand fixed rates."

Mr Alexander warned that the markets might be getting ahead of themselves over US and world growth prospects in the short term.

The risk of further terrorist attacks on the US remained and the situation in Afghanistan was anything but clear-cut.

The consensus among economic forecasters is now that the American economy will grow a scant 0.7 per cent next year, even worse than the 1.1 per cent growth that they expect it to manage this year.