RBNZ Governor says the rising OCR will hit borrowers in their pockets given the short duration of NZ home loans

By Gareth Vaughan

Reserve Bank Governor Graeme Wheeler says Official Cash Rate increases will take a toll on mortgage rates, and despite four OCR increases this year the OCR remains about 100 basis points below a "neutral" rate.

As widely expected the Reserve Bank today held the OCR at 3.5%, but reduced its forecast peak for interest rates by around 0.5% to around 4.8% by 2017.

Despite strong competition between banks in a low growth market keeping a lid on fixed-term mortgage interest rates, Wheeler reiterated that he believes the OCR hikes are being, and will continue to be, felt in borrowers' hip pockets. Wheeler also again compared the short duration of New Zealand mortgages to the much longer duration of mortgages in the United States, where he lived prior to succeeding Alan Bollard as Reserve Bank Governor in September 2012.

"If you look at the mortgage market here the interest rate duration is incredibly low. In the States 30 year fixed mortgages are the sort of standard mortgage, where the interest rate duration's very long. Here it's extremely low.  You've got 30%, for example, of the mortgages (as) basically floating rate mortgages, you've got another 32% that are fixed for less than a year," said Wheeler.

"So you are going to see monetary policy working in terms of the average time to when you get a rate reset, which I think at this moment is about ten and a half months."

His comments on Thursday are similar to ones he made at the last Monetary Policy Statement media briefing in June.

'Best possible rate' rises to 5.8%

In its latest Monetary Policy Statement the Reserve Bank said although fixed mortgage rates have moved only marginally since May, over the past year rates are up more substantially.

"The best possible (carded) rate over all durations from the major banks has risen from a low of 4.75% in September 2013 to 5.8% at the end of August 2014. This fully reflects the 100 basis points of hikes in the OCR this year, much of which was anticipated by markets and thereby priced into the mortgage curve long before the first OCR increase actually occurred," the Reserve Bank said.

"The attractiveness of fixed mortgage rates compared with the higher floating rate is encouraging householders to fix their mortgages. The trend towards fixed rates is not new, with the proportion of mortgage holders on floating rates steadily declining since its peak of 63%  in April 2012 to 29.9% in July 2014. The recent trend has been for borrowers to fix at the longer durations of two or three years. There were about $11.3 billion of mortgage flows into the one-to-three year fixed-rate buckets in the three months to July, up from only $3.9 billion over the same period a year ago."

"These flows pushed up the average time to re-price mortgages to 10.9 months in July, more than double the low of 4.7 months in 2012. The average two-year fixed mortgage rate from the big four banks is currently 5.99%, up slightly from 5.95% at the end of May," the Reserve Bank said.

With the Reserve Bank an outlier among central banks in developed economies in the sense that it has been increasing interest rates, Wheeler said a flattening in the yield curve was no surprise.

" So it's almost inevitable as you tighten and banks continue to finance offshore, that the yield curve will start to flatten," said Wheeler.

See all bank advertised, or carded, home loan rates here.

'100 basis points below neutral'

Meanwhile, Wheeler also made it clear further OCR hikes in the current tightening cycle remain on the agenda.

"We think some further policy tightening will be needed. If you look at interest rates (OCR) now, we've tightened four times. But they're still below neutral. We think the neutral interest rate is probably around 4.5%. So we're essentially about 100 basis points below neutral. So in that sense we're still acting in a stimulatory way in terms of impetus to growth even though we have tightened four times," said Wheeler.

Bank funding costs 'stabilise'

The Reserve Bank said after dropping for about two years, bank funding costs have now stabilised.

"After trending lower since mid-2012, bank funding margins have stabilised over recent months at an estimated 40 basis points over the OCR. Long-term wholesale rate spreads have fallen significantly since the Global Financial Crisis and European Sovereign Debt Crisis, but have stabilised over the past few months (figure 3.5). After contributing to falling funding costs since 2012, the spread to the OCR on retail term deposits has flattened out this year, as deposit growth has slowed," the Reserve Bank said.