Could your finances really handle a mortgage rate of more than 7%?

1. Inflation, the OCR, and mortgage rates

Normally I try to devote equal space to the five points covered in this column each week, but today’s needs more discussion of one thing in particular – inflation. Last week’s highly anticipated CPI release turned out to be quite a big surprise, with inflation basically unchanged at 7.2%, prompting a flurry of revisions to official cash rate projections. The consensus now is that the Reserve Bank is still behind the curve, despite having already acted earlier than other central banks. The OCR is now tipped to peak at 5% – potentially through two 0.75% hikes in November and February.

But the big question for borrowers, is what about mortgage rates? If the OCR does ultimately rise by at least another 1.5 percentage points, this would probably result in floating rates increasing by a similar amount. The picture is more complicated for fixed rates, as offshore wholesale rates matter here too (not just our own OCR). That said, it’s not out of the question that most of the OCR increase also gets passed through to fixed rates here, meaning that a typical one-year “special” (high equity) fixed rate rises from about 5.5% at present to at least 7%.

Now, a number of recent borrowers will have had their serviceability tested at rates higher than that, potentially even above 8% – meaning that theoretically they can handle the potential change. But an actual rate of 7% of more will be very close to or even above the serviceability tests applied to other borrowers, so that’s where some stress might arise. This is a key reason why I’d be wary of thinking that the house price downturn will end shortly; it’s more likely to roll on for a while yet.

For people with large mortgages, however, one silver lining is that the Reserve Bank’s current laser focus on inflation and sharp OCR increases does raise the risk of “overshoot” and a higher probability that they’ll need to quickly cut the OCR again at some stage if/when the economy starts to creak. For now, that’s a potential mistake that the Reserve Bank may be willing to make, as they deem persistent inflation to be a greater threat to NZ than an economic slowdown. Anyway, the next decision about the OCR will be November 23 – so expect a lot of discussion at that time.

2. Economy still expanding

Better news (for households) came in the form of the NZ Activity Index last week – a timely indicator of GDP – which expanded by 5.2% in the year to September.

3. Business confidence ticking higher?

Looking ahead, on Wednesday (1pm) we’ll get the ANZ’s measure of business sentiment for October, and if the recent trend continues, this will edge upwards again (admittedly from a low base). That would be encouraging for the housing market, as it should help employment creation, and mitigate some of the effects of higher mortgage rates.

CoreLogic chief economist Kelvin Davidson: "An actual rate of 7% of more will be very close to or even above the serviceability tests applied to other borrowers, so that’s where some stress might arise." Photo / Peter Meecham

4. Low deposit loans still low?

On Thursday the Reserve Bank will publish September’s mortgage lending figures, and my focus will be on the breakdown by loan to value ratio (LVR). The share of high LVR/low deposit lending has recently been dropping (from a low level), and it seems likely to have dipped again last month too.

5. Filled jobs should be positive

An encouraging piece of data this week should hopefully be Stats NZ’s filled jobs figures for September, due Friday. The rises seen in recent times look set to have continued last month – a great thing for overall household finances.

- Kelvin Davidson is chief economist at property insights firm CoreLogic

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