Bernard Hickey looks at what the Reserve Bank's OCR decision means for mortgage 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, but has warned it will increase it to 4.75% by early 2016. That would lift variable mortgage rates to 8% by then.

The bank said economic growth was showing "considerable momentum" and was becoming "increasingly self-sustaining." It said it needed to withdraw the stimulus of very low interest rates through 2014 and 2015. It forecast the Official Cash Rate would rise from 2.5% to around 3.5% by the end of 2014, with rate hikes starting in March or April.

Reserve Bank Governor Graeme Wheeler emphasized his plans to tighten monetary policy by being unusually specific about future rate hikes in the news conference after the release of the bank's quarterly Monetary Policy Statement. He said he expected the OCR to rise by 2.25% within the next two and a quarter years.

The banks said it was monitoring how its 'speed limit' on high Loan to Value Ratio (LVR) mortgages was affecting the housing market and repeated that it hoped it would slow inflation by 1% to 4%. Wheeler has said the bank would need six months to know how much the limit was slowing house price inflation. The bank said the impact was in line with its forecasts from what it had seen in its first two months of operation.

What does this mean for rates?

The Reserve Bank is essentially warning borrowers to expect mortgage rates to rise over the next couple of years as it returns interest rates to levels now seen as neutral or normal at around 4.75%. This would shift floating rates close to 8%.

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 early 2014, given the Reserve Bank's comments. But there has been a big change in the structure of interest rates in recent months because of the Reserve Bank's new 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 through their brokers because the banks are competing hard for business, particularly for borrowers with more than 20% equity.

Fixed rates

Fixed mortgage rates for sub-80% borrowers have been falling over the last couple of months as banks push hard to lend more in this unrestricted area. 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. 

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. Bank economists expect the OCR to start rising from March and rise to around 3.5% by the end of 2014. Some then see it rising only as high as 4%, while others see it going as high as 5.5%.

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 six months. Volumes of house sales have fallen in recent months because first home buyers and investors borrowing more than 80% have been pushed out of the market. But prices for those properties that are selling have continued to rise, in part because of a lack of new listings and strong demand from investors and migrants with plenty of equity.  

Some new building has started in Auckland, but remains below expected demand from migrants from overseas and from the rest of New Zealand. Migration has picked up in recent months as more New Zealanders come from home from Australia and fewer leave, which is increasing demand for housing.

The Reserve Bank forecast annual house price inflation of 10% and 3.5% 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.