By Bernard Hickey
The Reserve Bank of New Zealand has raised the Official Cash Rate (OCR) by 0.25% to 2.75% as expected, and has forecast it will raise rates by around 2.5% over the next three years. That would lift floating mortgage rates to over 8% by early 2017.
The bank issued its quarterly Monetary Policy Statement (MPS) and forecast New Zealand's economy would keep growing around 3.5% through 2014. It forecast inflation pressures to grow over the next two years.
"In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand," Governor Graeme Wheeler said.
The Reserve Bank forecast 90 day bill rates, upon which floating mortgage rates are based, would rise to 5.3% by early 2017 from 2.7% before today's rate hike. Advertised floating mortgage rates are typically around 2.5% to 3% above the 90 day bill rate. The bank forecast rate rises of around 1.25% in 2014 and another 1% in 2015.
Wheeler said in today's statement the bank's speed limit on high Loan to Value Ratio (LVR) mortgages had worked to moderate house price inflation. He said the bank's analysis showed that national house price inflation would have been around 11% now if the bank had not imposed the high LVR speed limit from October. House price inflation is now around 8.4%.
What does this mean for rates?
Banks have started increasing their floating mortgage rates and have already been increasing their fixed mortgage rates over the last six months in anticipation of today's hike. If the Reserve Bank's forecasts are correct, mortgage rates would rise to over 8% by the end of 2015.
Advertised floating mortgage rates have been broadly unchanged at around 5.7% since March 2011, but that started to change today.
Some banks have already started hiking their floating mortgage rates. But there has been a big change in the structure of interest rates in recent months because of the Reserve Bank's high LVR speed limit. Those borrowing less than 80% of the value of a property can get lower rates than those borrowing more than 80%.
Borrowers can often get cheaper than advertised deals because the banks are competing hard for business, particularly for borrowers with more than 20% equity.
Advertised fixed mortgage rates for sub-80% borrowers were flat to falling through mid to late 2013, but have risen around 0.5% on average since mid-December.
The banks' funding costs from overseas borrowing and local term deposits have been falling. However, rates for those borrowing more than 80% have been rising as banks try to discourage this limited type of lending.
Fixed rates depend more on wholesale interest rate moves than the OCR. They also depend on the banks' funding costs on international markets, which have been falling in recent months as financial markets are calmer.
Fixed vs floating
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 likely to rise in March, but may not rise as quickly through 2014 and 2015 as many in the market expect. This makes me less keen to fix for a long time.
What does all this mean for the property market?
The property market is in an unusual situation because of the Reserve Bank's high LVR speed limit and because of a surge in net inward migration over the last year. Volumes of house sales have fallen in recent months because first home buyers borrowing more than 80% have been pushed out of the market.
But prices for those properties that are selling have continued to rise, particularly outside of Auckland in the last couple of months. This is partly because of a lack of new listings and strong demand from investors and migrants with plenty of equity.
However, sales volumes and median prices fell in December and January in Auckland as the impact from the Reserve Bank's speed limit started to flow through.
Some new building has started in Auckland, but remains below expected demand from migrants from overseas and from the rest of New Zealand. There's also a lot of catching up to do from past under-building and the need to repair leaky buildings. Migration has also picked up strongly in recent months as more New Zealanders come home from Australia and fewer leave, which is increasing demand for housing.
The Reserve Bank forecast annual house price inflation of 6% and 5% nationwide in 2014 and 2015 respectively. It saw continued upward pressure on prices from a lack of supply in Auckland and Christchurch, and a rise in net migration.