Bernard Hickey looks at how to think about whether to fix or float, how long to fix and what the Reserve Bank may do about house prices

Bernard Hickey looks at how to think about whether to fix or float, how long to fix and what the Reserve Bank may do about house prices

By Bernard Hickey

We live in a very strange world at the moment.

New Zealand's economic and employment growth is rollicking along at over 3% and Auckland house price inflation is accelerating again into the double digits. The median house prices in Manukau and Auckland City were 25% higher in January than a year ago.

Normally that sort of growth would generate enough inflationary pressure to force the Reserve Bank to put up interest rates to cool things down and keep inflation between 1-3%. Instead, fixed mortgage rates are falling and the Reserve Bank can't hike the Official Cash Rate (OCR) because prices in New Zealand and around much of the world are falling.

Something appears different or broken in the bowels of the economic machine which means growth doesn't seem to be creating as much inflation as it used to. Central banks in Europe, Japan and China have responded to this lack of inflation and often outright deflation by cutting interest rates. Those who have already cut their rates to 0% are having to print money to buy Government and other bonds in the hope they can drag down longer term interest rates and fire up lending and economic activity.

The European Central Bank and the Bank of Japan are the main protagonists at the moment, launching and ramping up their programmes of 'Quantitative Easing', which is a fancy name for creating money out of thin air to buy Government bonds. So far it's been effective at firing up lending to buy assets such as bonds, stocks and property, but hasn't driven as much 'real' investment in new factories, jobs and new products and services, particularly in Europe and Japan. It appears to have worked better in America, although its inflation rate is also still slumping.

The Reserve Bank has estimated 2015 will be the biggest year for central bank Quantitative Easing since 2011. This has driven long term interest rates in Europe in particular to their lowest level since the 1400s. Swiss two year bond yields, for example, now offer a yield of minus 1.2%. That means savers are effectively paying money to banks and Governments to look after their money. Bond yields have collapsed over the last six months as investors in the world's most liquid markets bet that central banks will keep printing for years to come and that inflation will remain very, very low to the point of deflation. There are now US$2 trillion in invested in bonds and bank accounts that offer negative interest rates.

Earlier in February ANZ New Zealand was able to borrow 750 million euros from those same European investors experiencing negative interest rates. It borrowed at a rate of 0.625%. ANZ had to pay a bit more to swap that money back into New Zealand dollars, but would still have had plenty of margin to offer a keen fixed mortgage rate.

That's the backdrop for our mortgage rates, which have fallen as much as 1% over the last 9 months. As recently as the beginning of January, the average two year mortgage rate was 5.98%. In recent weeks banks have been offering 2 year specials of as low as 5.19%. One bank, HSBC, is now offering 5.29% for every single fixed mortgage from 1 year to 5 years. Just nine months ago, the average five year fixed mortgage rate was 7.3%.

One bank, TSB, is now even offering a 10 year mortgage at 5.89%.

Could they go lower?

The slump in fixed mortgage rates has made it much more difficult to justify paying the 6.74% offered by most banks for floating rate mortgages. The question then is: how long to fix?

The answer to that question depends on your view on where inflation in New Zealand and locally is going, and what you think central banks will do about it.

The jury is in overseas. They are treating this very low inflation and deflation as a cyclical issue that needs to be addressed with even lower interest rates and money printing. The People's Bank of China has also eased monetary policy in recent weeks, as has the Reserve Bank of Australia. The Reserve Bank of New Zealand is an outlier and despite the strong growth is seen unlikely to hike interest rates again for the forseeable future -- at least until well into 2016.  So far in 2015, Reuters reports 17 central banks have eased monetary policy.

So the global trend over the last six months has been for interest rates to fall ever lower. It's not just about falling petrol prices. There is now a growing debate about whether the deflation is structural and linked to changing technology, the globalisation of services and ageing populations. For now, central banks think it's cyclical. The wisdom of crowds in financial markets, particularly bond markets and stock markets, suggest it might be structural.

Structural or cyclical?

If it is structural then interest rates could remain low and possibly fall even further. Remember that interest rates averaged around 3% for all of the 1800s during the first age of industrialisation as new machines lowered the cost of production.

Some argue the world is entering a second age of industrialisation that delivers a similar type of 'supply shock' that lowers prices of goods and services for decades to come. The age of the smart phone has clearly driven down prices for many services, including shopping, accounting, music, telecommunications and taxis. Could we see many other areas such as education, health and financial services similarly transformed in a deflationary way?

Fix or float? And for how long?

My view for several years has been that interest rates stay lower and for longer than most economists have forecast.

That makes me more likely to fix for a shorter than a longer term.

The idea of a 10 year fixed mortgage scares me witless. That rate of 5.89% might look good now, but what if the long term average for mortgage rates is in the process of a structural fall to more like 4-5% instead of the 7.4% we've seen over the last decade? Imagine the break fees on a 10 year mortgage.

What the Reserve Bank might do about it

There's growing speculation the Reserve Bank will resort to new 'Macro-Prudential' measures to try to slow house price inflation without putting up the Official Cash Rate. Its first stab at 'Macro-Prudential' measures was its high LVR speed limit introduced in October 2013. That worked to halve the annualised house price inflation rate for just over a year, but it's wearing off now and Auckland's housing market is clearly in resurgent mode, thanks to a shortage of 15,000 to 20,000 dwellings, record high net migration and unfettered buying by cashed-up non-residents.

Reserve Bank Governor Graeme Wheeler warned in early February he was watching how the banks' activities were pumping up house prices and said the bank would talk more about the housing market in months to come.

Wheeler is worried New Zealand's house prices are among the most over-valued in the world relative to the history of incomes and rents and that any 'correction' could shake the stability of the banking system he is responsible for.

Most now expect he will introduce some form of new measures to slow mortgage lending. See more detail here in Gareth Vaughan's excellent summary of the current thinking.

Calculating the gains

There is a way to work out which mortgage and which rate saves you the most money, relative to floating rates. See the table below for the latest calculations on a NZ$500,000 mortgage.

Here's a table that shows the benefits of moving a NZ$500,000 mortgage of moving from a floating rate of 6.75% to the various fixed options, assuming different interest rate tracks. The gains are indicated as a positive and the losses are negative. The middle track for the OCR is in line with market expectations. See all mortgage rates here.

The latest estimates, given the drop in fixed rates in recent months, suggest fixing is cheaper than floating across the board.

OCR rate by mid 2016 One year fixed (5.39%) Two year fixed (5.19%)
OCR at 4.0% (low) + NZ$6,826 + NZ$11,263
OCR at 5.0% (middle) + NZ$9,775 + NZ$14,213
OCR at 5.8% (high) + NZ$13,011 + NZ$17,449

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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18 Comments

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How do I pay off my mortgage faster if I've fixed it? I'd at least want some flexibility to pay down debt if I got a bonus at work, for instance. Maybe set 10% floating, 90% fixed? Thoughts?

fix for 6months? if you get a bonus (good for you) pay it in at the 6months mark and re-fix for 6?
 

fix some and float the amount you think you might be able to pay early (before the end of the fix)

5.29% for 5 years fixed from HSBC sounds good but not when the money is borrowed offshore at 0.65% - margin too extreme. Should wait until say 4% or 4.5% for 5 years is available later in the year. Years of low interest rates and low inflation ahead.

Agree, I wouldnt think its wise to fix more than 6months right now. I cant see any sign there will be an uptick in rates but jumping in at some point maybe a good safe play, maybe.

Mortgages in Australia at 4.x%
In the USA / Canada at 2 - 3% Fixed with no punitive break fees
UK 2 - 4%     Taiwan / Singapore  2% 
NZ  -  Floating at 6.7%   NZ is a lucrative farm of borrowers. 
But we are sold the message of "historically low interest rates".
Fix for 6 months,  or 12 months maximum.   Prices are falling & that includes the price of money. 

Agree, so we here we are told that "NZ rates cannot go much lower" by the likes of Grant A?  (though whomever is probably right), yet the examples above raise an eyebrow.  Bring in the macro-prod tools please and then use these to target the problem areas and drop the insanely high OCR.  It hasnt worked aborod it wont work here. I mean its looking like it going to 2% anyway....do it orderly or simply panic when something major blows overseas.
 
 
 

"Something appears different or broken in the bowels of the economic machine which means growth doesn't seem to be creating as much inflation as it used to."
a) is it ever going to change?
A - no
b) Not something, its easy to spot if you want to look, but people wont look, so what is doing it?
A - peak oil ie lack of cheap and abundant energy, debt that cannot be paid back and financial smoke and mirrors, or maybe smoke and horrors.
 
 

If years of deflation are ahead, how come some think that assets prices will keep growing? It's a contradiction.

The Reserve bank of NZ knows that assets will also go down causing big holes in the financial system and over leveraged borrowers so my gut feeling is that they will not drop interest rates until the housing bubble bursts. Better to slow down mortgage creation to avoid more problems later.

What banks should do is to restrict unproductive loans (debt to buy houses) and to be more flexible, if necessary, with loans for productive purposes (buying machinery, etc).

After all if speculation and house prices are growing is simply because real productive economy is not providing enough returns. They should do whatever necessary to burst the bubble before it's too late amd whatever necessary to restrict loans for first home buyers. Let the big players suffer the losses.

"some" yes, but some asset prices are based on huge sums of make believe money and the assumption that they can sell to a bigger fool, and not on real returns of the asset. 
Think tulip mania.
What we will see at some point is the sharks will exit enmass for them ponzi scheme/ dead cat bounce and then we'll se whos naked, mostly us.
 
 

Exactly. And that's why the central bank should ensure that no more people are fooled to enter the ponzi scheme in a clear disadvantage situation against the ones on the top.
And they should do so through restrictions on first home buyers. If there is no common sense among the population to understand that buying at these prices with such a high ratio house price/income, at least the central bank can create the rules to prevent that the fools put the whle economic system at risk.
..And after that just sit and watch from distance who is left without chair once the music stops.

To date the Reserve Bank has acted only in the favour of Foreign and local 'investors' at the expense of first home buyers and Kiwis in general. I hold out no hope of Wheeler and Co ever getting anything right, incompetence is so far the kindest comment I can make regarding their efforts.
If you are looking to borrow....maximum 2 years....30% floating. I believe (and indicators so far keep heading that way) that rates will be mid 4% by xmas, which is still too high for the first world.
God help us if Wheeler comes up with further 'inspiration'.

House prices will continue to rise in Auckland simply because:
a. nowhere to spread - commuting becomes difficult
b. no end to Asian 'investment' - buying up stock and raising prices - flow on effect
c. greatest continual increase in population
So very simply, regardless of inflation values Auckland prices will keep going up due to supply and demand.

yes?
What if the reasons you enumerate are not causes but consequences?
a. what if there is nowhere to spread because "developers" keep "developing"in ridiculous places 20kms far from everywhere simply because there are fools willing to buy there because they can't afford to buy in convenient locations?
b. what if Asians (and British, and locals..) buy stock simply because the returns are more attractive than productive economy?
c. what if the population grows because there are jobs and a relative attractive job market and that creates positive migration flows that will stop as soon as some other markets overseas are more attractive or as soon as there are not that many jobs in NZ or lower salaries?
 
I just don't agree with your view. Prices can continue growing in Auckland for some months, but as soon as the global shake happens (sovereign bond crisis?) everybody will run away quickly. It's common sense that eventually a correction will happen, and there are many variables that could cause it, 

you're both right, which is why the investments seem pretty solid.  prices go up, so demand is there.  Demand is there so prices go up.  Sales happen so people move there, because people go there, there's increase in employment demand and sales.

Question is: Will it level or pop?

Well, it's a matter of asking if it's possible to increase house prices further than 10, 20 or 1000 times the household anual income.. there must be a limit there.
 
And there is a limit on the risk a bank are willing/allowed to take. If in their balances they have assets (houses backing loans) worth ridiculous amounts of dollars ("market prices").. there must be a limit there.
 
In the medium long term there will be a correction one way or the other. In the short term.. who knows? How to measure people's faith or irrational desire to own a property at any price?

Your views short term are correct. Houses wont go up 1000 times.
But if you bought a house in the 50's for 1000 pounds, they have definitely gone up a 1000 times since then.
Its all relative. Whilst apartments in Hong Kong cost 2 to 5 million then buying in Auckland for and extra 100 or 200 thousand at auction for a house on a section with 4 or 5 bedrooms is no big deal. We haven't even seen the start of aggressive Chinese property purchase. Watch this space.
Might pay to learn Cantonese now.

Interesting feedback, which doesn't really contradict what I said. Consequences or causes, matters little, the results are the same. NZ survived the GFC and prices continued to rise. I do not see any levelling in Auckland's future at all. It would take the government to stop foreign ownership outright before any bumps or blips occurred. And that isn't going to happen with Key's love affair with China and his head-in-the-sand attitude to central Auckland being bought up wholesale by them.