Bernard Hickey looks at what the Reserve Bank's OCR decision and statement might mean for interest rates and house prices

By Bernard Hickey

The Reserve Bank of New Zealand has again held the Official Cash Rate (OCR) at a record-low 2.5% as expected and has repeated its pledge to keep it there for all of 2013.

However, the bank did warn it would need to remove monetary stimulus in future and was watching closely for any signs that construction cost and house price inflation was spilling over into wider inflationary pressures.

Economists said the Reserve Bank had therefore adopted a 'tightening bias' and was on track to hike the OCR from early 2014.

The bank made no comments about using its planned 'speed limit' on high loan to value ratio (LVR) mortgage growth, but that was expected, given the bank likes to separate monetary policy from the issue of improving banking stability, which is what the speed limit is focused on.

What does this mean for rates?

The Reserve Bank has previously forecast it would not need to increase the OCR until mid to late 2014, but economists are more worried about inflationary pressures and see a March 2014 rate hike as more likely. The bank has forecast rates might rise by around 1.5% by early 2016, whereas economists and financial markets see rises of more like 2-3% over the next three years.

Floating rates

Advertised floating mortgage rates have been broadly unchanged at around 5.7% since March 2011 and are likely to stay that way until at least until early 2014, given the Reserve Bank's comments. However, borrowers can often get cheaper deals through their brokers because the banks are competing hard for business.

The Reserve Bank has forecast the 90 day bill rate, which is the basis for floating mortgage rates, will only start rising from mid 2014, and then rise around 1.5% by early 2016.

This suggests a peak for floating rates at around 7%. Some economists though see floating rates rising as much as 3% to closer to 8%.

Fixed rates

Advertised fixed mortgage rates have been rising a bit over the last two months because of a rise in global interest rates and renewed talk of a 'tightening' bias by the Reserve Bank.

However, most shorter term advertised fixed rates remain below floating rates, making the fixed vs floating decision a tough one.

Fixed vs Floating

Fixed rates depend more on wholesale interest rate moves rather than the OCR. They also depend on the banks' funding costs on international markets, which have been falling.

The fixed vs floating decision depends on your outlook for the OCR and your personal situation. A flat to falling OCR makes floating more attractive, while a fast rising OCR makes fixing more attractive.

In my view, the OCR is flat for now. It may rise next year, but not quickly because wider inflationary pressures are so subdued. That may change though if the Christchurch rebuild and Auckland's house price boom start flowing through to the rest of the economy.

What does this mean for the property market?

The prospect of low interest rates for longer is encouraging many first home buyers and Christchurch to borrow and buy, particularly in Auckland and Christchurch where migration and a shortage of undamaged and watertight buildings is putting upward pressure on house prices. Some new building has started in Auckland, but remains below expected demand from migrants from overseas and from the rest of New Zealand.

The expected introduction by the Reserve Bank of a 'speed limit' on high LVR mortgage growth in the coming months may dampen growth, but opinions are divided on that.

The Reserve Bank recently forecast annual house price inflation of 11% and 7% nationwide in 2013 and 2014 respectively, but also suggested a scenario where house prices rose 14% in 2014. Elsewhere in New Zealand, where there is more housing supply and less net immigration, house prices are more subdued, although they are heating up as the Auckland and Christchurch inflation spreads.