BNZ chief economist says nobody in the past five years has been able to predict interest rate levels

BNZ chief economist Tony Alexander believes that fixed-term mortgage rates will rise further over the next few months - even before the Reserve Bank starts raising official rates next year.

Alexander told interest.co.nz that recent moves by the big banks on mortgage rates were mainly influenced, firstly by an expectation that the RBNZ would be raising rates next year, but more particularly by increases in the cost of funds from offshore for banks. Those rises in interest rates offshore were due to expectations that the US Federal Reserve would soon start to "taper" its quantitative easing programme.

"It hasn’t even started yet but it has already had a big impact on their currency, sharemarket, interest rates and that’s the key reason why our fixed rates have gone up so far.

"In terms of where they go it is a relative no-brainer. Unless we get foot and mouth, unless the world economy falls over – and the data most recently are actually the opposite, they are improving out there in China the UK, Europe, the US etc – unless that happens these interest rates go up and it is simply a question of trying to pick where is the peak going to be, what will the levels be, how fast will interest rates go up.

"And the very strong warning I would give everybody there is, no-one in New Zealand and probably any other country for the past five years has a record of any accuracy in forecasting interest rates.

"They are going to go up and the tendency at the start of these interest rate cycles is to under-estimate how high they are going to go."

Alexander says it can therefore be expected that there will be further rises in fixed rates - though probably not floating rates - over the next few months. Though perhaps the rate rises in the next few months would not be as much as had been seen just recently.

"…If you are looking at moving some of your interest rate exposure from floating into fixed then the incentive is to move sooner rather than later."

What would he do?

So, if Alexander himself were looking are organising a mortgage at the moment, what would he be doing?

"I would be looking for somebody maybe offering some sort of discounted rate in the three to five year area. Hey, they’ve just gone up, so, whatever I’m doing now is going to be more expensive than two weeks or maybe six weeks ago.

"I would still be looking to have a mixture of floating, sort of six, 12, 18-month fixed because that’s where the banks are concentrating their competition. You get some nice low interest rate there. Concentrate on paying down your principal. But I would want some security against what might happen this cycle.

'Not fixing at all'

"Two year is not fixing at all. There is a tiny amount of security bought there. You need to be looking at maybe moving maybe a third of your mortgage towards a three to five year area. You are going to be paying more to do that. But it is like an insurance premium against the Reserve Bank having to tighten aggressively further out. We don’t think they are going to have to. But that’s exactly what we thought in sort of 2003-04 as well and they ended up having to move a long way." 

The Reserve Bank is introducing so-called speed limits on high loan to value mortgage lending from October 1. See here for articles on LVRs.

The RBNZ is picking annual house price inflation to peak at about 10% within the next six months and then fall - to about 4% - by the end of next year. It expects that the LVR measures could trim 1 percentage to 4 percentage points - or to take a midpoint, say 2.5 percentage points - off house price inflation.

Is that a believable forecast?

"Well, not really believable, no," Alexander says.

"I’ve never seen anybody plonk in front of me what I consider to be a good model for forecasting interest rates. I’ve seen some pretty sophisticated stuff over the past couple of decades and its been completely wrong."

Likewise, Alexander believes that the RBNZ picks for the peak of inflation over the coming years - at around 2.2% - may end up falling short.

Initiatives such as the Auckland Housing Accord, with its target of 39,000 new houses for the Auckland housing region in the next three years are likely to prove inflationary.

Inflation risks

"The risk is it [inflation] goes higher than what the Reserve Bank have got there at the moment."

Alexander says the resources are not going to be there for the big Auckland build. He points to the fact that there is already strong competition for labour even with relatively high unemployment.

"You’ve got nil and Buckley’s chance, as the Australians say, of this 39,000 extra houses being built in Auckland in the next three years. It’s simply not going to happen.

“I certainly applaud all the efforts being made to free up land, to speed up the consenting process etc but in some regards freeing up land, it won’t make much difference because you might have more land available but that doesn’t do anything at all to change the deficiency of availability of the builders, of the surveyors of the engineers, of the drain diggers etc. That will be a key constraint. It will push inflation up.”

Monitoring

Alexander notes that the RBNZ have said they will be monitoring the extent not just of house price rises but of construction costs feeding through to the rest of the economy.

"The risk is [that it will be] more than they are thinking. The risk is that interest rates are going to have to be given a wallop by the Reserve Bank – not so much next year. Maybe 2015 and 16."

Alexander doubts that house price inflation will peak at just 10%.

"History would certainly say no, you are probably going to peak at something greater than that. But look every interest rate cycle, every economic cycle, housing cycle is different."

Unique

Alexander says the "unique aspect" this time around is the Christchurch rebuild. But he also points to the shortage of housing in Auckland and how people will react to that shortage as a key factor this time around.

"If people are strongly of the opinion the shortage is there, the shortage is going to continue they are going to remain willing to borrow money and try and buy a property as soon as they can even as the interest rates go up.

"So, that shortage element in Auckland is the new thing and I would suggest in particular a rising awareness over time of ‘the shortage isn’t going to disappear is it?’. We’ve been looking at a shortage in Australia now for about eight or nine years and it is also getting worse.

Ongoing shortages

"Many parts of the world are moving to a sustained housing shortage situation and that’s going to be it for the entirety of this housing cycle in New Zealand."

Alexander has previously said he thinks floating mortgage rates could peak at around 8.5% in the next three or four years - and he still believes that.

"I think there is upside risk out there and that’s why if I were a borrower I would be looking at some of that three to five year fixed interest rate. You know coverage basically. Two years isn’t going to really give you protection against that.

"...Uncertainty is still through the roof out there in the world economy and when you’ve got massive uncertainty it pays to try and lock down some of your variable costs. So, even if I didn’t have the suspicion that there’s a bit more inflation out there down the track than people are thinking I would still be talking personally myself in terms of taking out some fixed interest rate cover."