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Welcome to the latest installment of a weekly feature here on the Fundit blog, where I review the bank’s regular economic reports, and, along with my own views, presenting the relevant points in an easy-to-read format. I welcome your questions and comments – feel free to send them through to glenn@fundit.co.nz

Interest Rate Outlook

The Reserve Bank yesterday released its July update, upping the OCR from 2.75% to 3.00%.

Currency market fluctuations aside, this didn’t have much of an impact – continued increases in the OCR have been foreshadowed by the Reserve Bank for a while now, and having been anticipated by the market these increases had already been ‘priced in’ to longer-term rates.

Historically, the average amount over the OCR that banks have charged as a floating rate has been around 2%. The advent of the global financial crisis caused this to balloon somewhat – since January 2009, the average differential between the OCR and floating mortgage rates has been well over 3.5%. In saying this we can observe a definite downward trend in recent months, indicating lenders are requiring less of a risk premium over and above their own cost of funding, which in turn points to a more favourable outlook from banks about the ability of their borrowers to repay loans. Improving consumer sentiment could be one of the many factors behind this.

What does this mean for you? Assuming the downward trend in OCR/floating rate differential continues (a big assumption it must be said) expect floating rates to increase marginally, probably to around 6.10%, over the next few weeks. Fixed-term rates already included an expected rise in the OCR, so I wouldn’t anticipate much movement on that front – although following the Reserve Bank’s lead many commentators have flagged a higher probability of a more gradual OCR rise, which could see longer-term fixed rates decrease slightly. Incidentally, this is why even after an OCR increase you wouldn’t be in a better position now if you’d decided to fix last week: the market interest rates for fixed rate mortgages already included an expected rise in the OCR.

There is one complicating factor worth mentioning, which is the impact that international wholesale rates have on our fixed mortgage rates. Substantial falls in wholesale rates have seen fixed rates fall over the last few months, which could continue if uncertainty persists.

Breakeven (Implied Future Interest Rate) Table

Read last week’s post for an explanation of what this is, and how to use it.

No change on this front, as expected – it’s going to take a while for interest rate changes to propagate through the system. Of note is the two year fixed rate: if you fixed for one year now at 6.46%, you’d need one year rates to rise by 1% over the next year to be worse off than just fixing for two years now at 6.99%. Do you think this will happen? If not, the current two year rate would seem to be expensive.

From the Banks

ANZ have released their latest Property Update at http://anz.co.nz/commercial-institutional/economic-markets-research/property-focus/ (a good read), which includes the following:

“While floating rates have increased, fixed rates have fallen substantially in the past month, led by the long end. This has seen the difference between fixed and floating rates contract substantially. This raises the obvious question – is it worth fixing now that fixed rates have come down? With so much uncertainty about, especially in relation to the state of the housing market, we still favour the much lower floating rates.”

ANZ also goes on to validate much of what I wrote last week about when you should choose to fix or float (which is refreshing!), though they do complicate the issue by introducing the concept of a ‘liquidity’ or ‘term’ premium.

Just to further validate what I wrote last time, BNZ takes a different tack in Tony Alexander’s weekly update (http://bnz.co.nz/About_Us/1,1184,3-29-319.html?tid=PHPTonyAlexander):

“Our analysis still falls slightly in favour of fixing two or three years rather than floating. So personally I would fix three years expecting that by April next year the floating rate will be above the current three year fixed rate of 7.3%. The floating rate will probably be above the current two year fixed rate of 6.99% come March next year.”

Clearly ANZ and BNZ think different things, as will everyone else in the market – their aggregate views form the market expectations of interest rates. Thus the real question again becomes apparent when choosing to fix or float: do you think you’re correct about future interest rates, or the market?