Will mortgage rates fall as much as you’re hoping?

Interest rates are headed lower, which will take the pressure off household budgets and give borrowers a reprieve.

The bad news is that they might not fall quite as much as some are hoping.

With the first rate cut under its belt, the Reserve Bank has several more in the pipeline.

Its projections suggest the OCR will keep falling from here, and settle at about three per cent by early 2027.

Financial markets also expect the policy rate to land at those levels, although they see it getting there a little sooner.

The OCR is like the Reserve Bank’s brake or accelerator pedal, and it’s key tool to influence activity and inflation.

The “neutral OCR” is the level where the economy is in balance, and it isn’t being sped up or slowed down.

It’s difficult to pinpoint exactly where this tipping point is, but it’s an important concept for policymakers, and the rest of us.

Historically, the Reserve Bank has thought it to be about two per cent, in line with its inflation target.

Ignoring the pandemic and its aftermath, that’s roughly where the OCR has averaged in recent years.

In the decade preceding COVID, the OCR fell as low as one per cent and pushed as high as 3.5 per cent.

It averaged 2.3 per cent over the entire period, and spent eight of those ten years below three.

Today, the Reserve Bank believes the long-term neutral level of the OCR is 2.8 per cent, up from 2.3 a year ago and above the historic estimate of two.

It’s not alone.

The Federal Reserve in the US has also been revising its estimate of the long-run policy rate higher.

It sees it at 2.8 per cent as well, compared with 2.5 per cent at the beginning of the year.

Economists can’t precisely calculate where neutral is at any given time, but most experts agree it’s higher than it used to be.

Globalisation moving into reverse, higher government debt, demographics and climate change action have been contributing factors.

For the typical homeowner, the upshot is that mortgage rates might not fall quite as much as they’d like.

Over the past several years one and two-year mortgage rates have been, on average, 2.3 and 2.4 per cent above the OCR.

This gap widened during the ultra-low interest rate COVID period, while it’s been much narrower since the OCR pushed above five per cent last year.

Where it sits in the coming years will depend on several factors, including how competitive the mortgage market gets.

However, history would suggest borrowing rates for these popular mortgage terms will be about two per cent higher than the OCR, give or take.

Financial markets see the OCR falling to four per cent by April 2025, which implies mortgage rates of about six per cent.

Two years from now, it is expected to have reached its three per cent nadir, which implies mortgage rates of about five per cent.

That’s a big fall from the seven per cent plus peak, but it’s well above that of the crazy COVID era, as well as the four years before that.

If five per cent is indeed as good as it gets, the coming years will more closely resemble the post-GFC period of 2009 to 2015.

Back then, the OCR oscillated within a range of 2.50 and 3.50 per cent and it averaged 2.75 per cent, almost bang on the latest estimate of where neutral is.

Over those seven years, the one-year mortgage rate averaged 5.1 per cent.

It’s true, interest rates are headed lower and borrowers are right to feel more upbeat, optimistic and encouraged about what’s ahead.

However, don’t get ahead of yourself. If the neutral OCR is higher than it used to be, the “new normal” for mortgage rates will be too.

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