Opinion: What the RBNZ's MPS means for fixed and floating mortgage rates

By Bernard Hickey

The Reserve Bank's Monetary Policy Statement last Thursday seemed on the face of it to be a non-event.

The central bank left the Official Cash Rate on hold and reiterated its downbeat outlook for the New Zealand economy. But it was the Reserve Bank's decision to further lower its forecast track for the 90 day bill rate that really caught the eye. See more from the RBNZ's MPS here. This caps an extraordinary year of forecast changes for the bank.

It has changed the landscape for interest rates and helped reinforce a massive shift in behaviour in the mortgage market away from fixed mortgages to floating rate mortgages. Back in March the Reserve Bank was forecasting the 90 day bill rate would rise from around 2.8% then to a high of 6.5% by the end of 2012. That implied floating mortgage rates would rise to around 9% from around 6%.

That was more than enough to encourage some to fix their mortgage rates for two years at around 7.2% But since then the Reserve Bank has begun to realise that the huge stock of household debt bearing down on households has changed the way the economy responds to low interest rates.

Unlike in previous years, low interest rates are not encouraging quite so many home buyers out into the market to borrow more to buy homes. Instead, many households and businesses are sitting on their hands.

Worried banks are now even resorting to the age old tactics of offering discounts on legal and establishment fees and trimming fixed mortgage rates to encourage borrowing interest. These blandishments are boosting demand at the margins and life is beginning to return to some of the richer suburbs in Auckland and Wellington where tax cuts are helping to boost pay pay packets. Mortgage approvals hit their highest levels for the year last week. See more here.

But any heat is sporadic and not ready to spread out into the suburbs on the fringes or into provincial areas.

This lack of activity in the housing market is one of the factors driving the Reserve Bank's forecasts for economic growth and the 90 day bill rate lower through 2011 and into 2012. Now the Reserve Bank is forecasting the 90 day bill rate will only rise from 3.2% now to a peak of 4.4% by the March quarter of 2013.

This suggests that floating mortgage rates are only likely to rise to around 7.4% over the next two years. That makes a three year mortgage of around 7.1% far less attractive, particularly for those who have benefited from being on a low floating rate for the last year as the interest rate track has dropped. This has helped change the type of mortgages people are choosing. Most fixed mortgages are now being turned into floating rate mortgages when they roll over. See all mortgage rates here.

The Reserve Bank confirmed last week that the average time to reprice mortgages has dropped to just 8 months from nearly 20 months at the height of the housing boom. Over 42% of the nation's mortgages are now on floating rates, up from a low of around 12.5% in August 2007.

This would appear to add power to the Reserve Bank's only monetary policy tool -- the Official Cash Rate -- because any change will have a more immediate impact on household finances.

The irony for the Reserve Bank is that the Monetary Policy Statement made clear that its monetary stimulus of a low Official Cash Rate is not having as much effect as expected because home owners are not adding to their already crushing debts.

Borrowers can now look forward to floating rates remaining to flat for the next six to 9 months. Many, however, will choose not to add to their debts after that fright from earlier this year at the prospect of floating rates rising to 9%.