By Bernard Hickey
The Reserve Bank is expected to leave the Official Cash Rate (OCR) on hold on Thursday morning and most economists believe a rate hike is unlikely before the end of this year because inflation is under control and the problems in Europe are slowing economic growth.
However, the housing market is beginning to bubble again in central Auckland and Christchurch where undamaged and watertight housing supply is limited and where migrants want to live. The prospect of low (and possibly even lower) interest rates is also encouraging some first home buyers to load up with more debt they believe they can afford.
There are few signs yet this surge in housing activity in these specific areas is spreading around the country in a similar way to the boom in prices from 2002 to 2008, although most economists see some moderate price growth over the coming year as unemployment remains relatively low, commodity prices remain high and the rebuilding boom in Christchurch gets under way. See more here in our report on the latest house price figures.
The decision to go with a fixed mortgage or floating mortgage remains dependent on any borrower's view on interest rates and how much certainty any borrower needs on regular payments.
Borrowers who are very nervous about their jobs or want to budget a fixed repayment for years to come are more likely to fix. Those who believe official interest rates are likely to remain flat or even fall because of low inflation and slow economic growth are likely to choose floating.
The interest rate outlook
Last week the outlook for inflation and interest rates changed substantially when the Consumer Price Index actually fell in the December quarter and the annual inflation rate slumped to 1.8% from 4.6% in the previous quarter. Most of this slump is linked to the removal of the October 2010 GST increase from the annual figures and a big drop in tomato and lettuce prices, but it was still much weaker than both economists and the Reserve Bank expected.
See more here in Alex Tarrant's article from last week.
Before the figures many economists expected the Reserve Bank to begin increasing the OCR from its record low current level of 2.5% from September of this year. Remember that the Reserve Bank made an emergency cut in the OCR on March 10 last year to 2.5% from 3.0% and has left it there ever since, despite suggesting through most of last year that it would have to increase it back to more normal levels.
However, the economy has stuttered along ever since then as many households try to save money and repay debt, and the European economy slumped into a sovereign debt crisis. Also, the Christchurch rebuild has been slow to get under way because of problems with insurance, zoning and new earthquakes.
The Reserve Bank forecast in December that it saw short term interest rates increasing from midway through this year with an implied OCR peak in 3.75% later next year. Assuming the relationship between floating mortgage rates remain the same (about 3% above the OCR), then floating mortgage rates would peak at around 6.7% by the end of next year, which would make two year fixed rates being offered right now of around 5.8-6% relatively attractive if you assume the Reserve Bank is correct.
Financial markets, meanwhile, are expecting the Reserve Bank to hold the OCR around 2.5% well into next year, or even cut it, which would make floating more attractive.
Here's what the economists say
BNZ's Head of Research Stephen Toplis said this week he still expected the Reserve Bank to start increasing the OCR from its September 13 Monetary Policy Statement (MPS). Toplis then expects the central bank to hike the OCR to a peak of 4.25% over this year and next.
He expects the Reserve Bank to keep signalling rate hikes on Thursday, which means he thinks fixed rates offered for 2 to 5 year terms offer good value.
"It will surely lean on the side of emphasising a continued tightening bias than sounding in any way iffy about one. The latter would be like a red rag to the already bullish debt markets, wanting to price rate cuts," Toplis said.
BNZ Chief Economist Tony Alexander said in his January 19 weekly overview he saw the OCR on hold in 2012 and he favours floating rather than fixing.
"Locally NZ data are not suggesting the economy’s growth rate is accelerating and there are plenty of risks still to the economic outlook. Therefore, until we get some greater clarity with regard to Europe, the United States, the timing of the Christchurch rebuild, and when farmers start spending more money, I find myself still extremely happy to sit floating," Alexander said.
He sees the housing market slowly improving, "driven by a shortage of listings and lowest construction in 40 years encouraging buyers with foresight to get in before a stronger labour market brings a wave of buyers in," although he notes rental property investor activity remains weak.
Westpac's Economists see the Reserve Bank hiking the OCR from September 13, although notes the markets see the OCR on hold until Mid 2013. Westpac still sees inflation building in coming years, forcing the Reserve Bank to hike the OCR to a peak of 6% by 2015.
"We think the RBNZ will now be comfortable a later starting date, though it need not be specific about it in this Thursday’s one-page communiqué. Our pick remains for a September start, on the basis that the RBNZ will still have an eye towards post-quake reconstruction and a pickup in the domestic economy," Westpac said.
ASB's Economists expect the Reserve Bank to leave the OCR on hold until December 6. It then sees the OCR rising by 1.5% to a peak of 4% in late 2013.
"With current inflation pressures subdued, and considerable downside risks to growth, the RBNZ has no urgency to increase the OCR before December 2012," ASB said.
It expects house prices to rise nationwide at an annual rate of around 3% heading into 2012, "underpinned by a continued contained level of housing inventory."
"House price growth in Auckland is likely to be stronger than that, reflecting its relatively tighter market," ASB said.
ANZ Economists see the Reserve Bank holding the OCR for most of this year, with no great urgency to move either way because of contained inflationary pressures and the risk of a bigger global slowdown.
"At 2.5% and with pressures on capacity remaining present the OCR will eventually need to move higher, barring global meltdown. However, the RBNZ can afford to be patient," ANZ said.
ANZ is cautious about house prices.
"With household debt still very high, future increases in consumer spending (and house prices) seem likely to be income-driven rather than debt-driven as in the early 2000s," ANZ said. "We still view the balance sheet constraint (debt levels,affordability) as dominating supply-demand balance measures in terms of the outlook. The former portends a slow grind for the property market ahead."
Floating vs fixing?
Before the Global Financial Crisis this was an easy decision for most borrowers because fixed mortgage rates were almost always cheaper than floating rates. But that changed after the Lehman Bros crisis because banks were unable to find the cheap and easy short term wholesale funding that helped them keep fixed rates lower.
Since then, the Reserve Bank has also tightened funding rules that encourage banks to fund more locally and for longer terms than before. This has made fixed more expensive than floating and is likely to keep it that way.
Any decision to fix or to float depends on how quickly and how high interest rates will rise. Floating makes more sense if interest rates stay lower for longer, while fixing makes more sense if the OCR rises soon, quickly and to a high level. Fixing may also make more sense for those who place a premium on having certainty about their repayments, regardless of whether they are higher than staying on floating.
Also see our calculator for working out whether fixing or floating is cheaper over the life of a fixed term mortgage.
My view:
I think high household and government debt levels in many large developed economies will restrain global growth for some years to come and New Zealand households are being a lot more cautious about taking on new debt and spending than they were before the Global Financial Crisis.
Further financial market turmoil and a slow Christchurch rebuild may keep the OCR interest rates lower and for longer than economists think. That means I think floating is cheaper than fixing for now, mainly only because I have a more bearish view on global growth than the RBNZ and economists.
We have a calculator which works out whether fixed is cheaper than floating, given the assumption that the RBNZ's forecast track for the 90 day bill rate is correct and given the current average mortgage rates. See the current mortgage rates offered by banks here.
I also think house prices will grow less than inflation and may fall further in some areas. I stick to my longer term view that house prices are still over-valued and will eventually fall to around 15% below their 2007 peaks.
They are currently around 3% below that peak and are down more than 11% in inflation-adjusted terms since that peak, which is the biggest fall in real house prices since the stagflation of the 1970s.
See David Chaston's article here.
(Updated January 24 ahead of January 26 OCR decision)
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