INSIGHTS

BUCKLE UP, IT'S GOING TO BE A BUMPY RIDE

Mark Lister, 25 November 2021

The Official Cash Rate (OCR) is expected to spend the next three years rising and for some of us, it’s going to hurt.

Inflation is high, the path of house price rises is unsustainable, and the economy is running hot against the backdrop of an extremely tight labour market.

Higher interest rates will go a long way to fixing some of that, as they always do. This will be a good thing from a financial stability perspective, but it will come at a cost for many.

After 18 months at a record low of 0.25 per cent, the OCR has quickly moved to 0.75 per cent. The Reserve Bank sees it above 2.00 per cent by the end of next year, and above 2.50 per cent a year after that.

OCR, mortgage and deposit rates (based on historic relationships)

OCR, mortgage and deposit rates based on historic relationships2

Over the past five years the one-year mortgage rate has been, on average, about 2.50 per cent above the prevailing OCR.

The one-year mortgage rate fell to a low of 2.19 per cent in June, and that same rate has increased to 3.65 per cent today, a very sharp rise in the space of five months.


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Based on the aforementioned relationship, if financial markets are correct with their OCR expectations, it could be five per cent by November 2022.

For someone with a $700,000 mortgage, the difference in payments between the recent lows and today’s rate is $122 a week, while the difference between June 2021 and a five per cent mortgage rate is $241 a week.

A weekly increase of $241 equates to an annual uplift in payments of more than $12,500. Most of us pay our mortgage out of our after-tax income, so if you’re on the 30 per cent tax rate, we’re talking about the equivalent of an $18,000 hit to your salary.

The precise magnitude of any increase will depend on when you locked in a rate and for how long, but you get the picture. Money is going to get a lot more expensive.

Some two thirds of fixed rate mortgages are due to reprice within one year, so there’s a fairly big group of people who could be in for one heck of a shock.

This will impact confidence, spending and the housing market. After all, that’s kind of the point.

In fact, the only thing that looks likely to dissuade the Reserve Bank from this course of action is an economic pothole along the way. When put like that, it seems all paths lead to a slowdown over the coming year or two.

It’s not all bad, mind you.

Most homeowners have the equity to absorb a fall in asset prices, we know the banks stress test potential borrowers at much higher interest rates, and a healthy labour market has meant households have had very stable incomes of late.

Besides, if the wheels start to wobble after a few more OCR hikes in quick succession, the Reserve Bank will pause.

It’s also comforting that everyone is so wholeheartedly expecting a swift return to more normal interest rates here in New Zealand. Elsewhere, if feels like some central banks are dragging the chain a little.

Other countries could be in for a bigger surprise if policymakers are forced into an abrupt about face, should they admit inflationary pressures aren’t as transitory as they think.

For us, it’s in the price. For others, maybe not quite so much.

That’s one reason I think our sharemarket could prove more resilient than expected. Having seen rising interest rates on the horizon, it has responded accordingly by lagging other markets by a reasonable margin, including housing.

New Zealand share prices are down slightly in 2021 and are only seven per cent above pre-COVID levels, in contrast to house prices which are up an astounding 40 per cent since the end of 2019.

Somewhat ironically, because it is dominated by stable, low risk businesses, our sharemarket tends to perform quite well during times of economic malaise.

The next 12 months will be an eventful period for the economy, as well as housing and financial markets.

Buckle up.

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