Interest rates
Monday 03 August, 2009
There have been only minimal movements in wholesale interest rates over the coming week. Bill yields have as expected stayed close to 2.8% while swap rates initially crept a tad higher on the back of a general reduction in risk aversion associated with rising sharemarkets causing investors to shift funds away from fixed interest assets. This is a trend we have been expecting to see happen since at least March and although the bulk of the move for this year has happened the drift from here on out will continue to be upward though at a slow pace we feel. However, following this morning’s more dovish than expected rate comments from the RB swap rates have edged back down slightly.
The RB retained their easing bias and in fact near explicitly stated that unless the currency falls back they would be inclined to cut the cash rate further. However that would be quite problematic because while it would shore up the economic recovery now underway it would tend to boost the housing and eventual retailing upturn as floating mortgage rates fell, but probably have minimal impact on the exchange rate. After all, if a record low 2.5% official cash rate leaves the NZ dollar at an above average trade weighted index level and near US 65.5 cents, what possible influence would a small 0.25% or even 0.5% reduction have?
The two year swap rate has ended up virtually unchanged from 3.99% last week after being at 4.07% this morning before the RB statement. The five year rate has held steady near 5.40% from 5.45% last week. .
Key Forecasts
• No more monetary policy easing this cycle.
• Medium to long term housing rates have seen their multi-year lows – stop-start rises now lie ahead. Speed unclear.
If I Were a Borrower What Would I Do?
Personally I would like some certainty in this uncertainty environment so still prefer the three year rate at 6.99%. However what traditionally happens when the yield curve facing home owners gets steeper is that people borrow at shorter and shorter rates. Therefore most people who are taking out a new mortgage or coming off an old fixed rate are either floating at the Total Money rate of 5.99% or fixing for 6, 12, 18, or at most 24 months.
This is great in the short term because it gives people a nice low rate. But it would be best to take advantage of this good cash flow situation to accelerate principal repayments rather than blow the savings on appliances we probably don’t need, or holidays the never-ending inserts in newspapers seem to imply we should always be taking.
We expect the Reserve Bank will start raising the official cash rate from the middle of 2010 at the earliest with the rate gaining around 3% by the end of 2011. That means the currently low short term interest rates are going to be 2% - 3% high in perhaps 18 months time. As long as one budgets for that then things will be fine for borrowers. Just don’t get caught out like millions of Americans who borrowed at 2% floating mortgage rates in 2003-4 then saw their repayments soar once these floating rates rose to 6% and more by 2006. This was a huge shock because historically Americans have borrowed at fixed rates for around 30 years. They went floating in 2003-05 because those rates were much lower than the long term fixed rates. That change in borrower behaviour sacrificing certainty for short term cash flow is one of the reasons the world economy is in its worst state since 1946.
Source: Tony Alexander, Chief Economist of the Bank of New Zealand
