Home loan crunch: How often does Reserve Bank stick to its guns on interest rates?

ANALYSIS: Over the past two years interest rates have skyrocketed, with the average one-year rate rising from 3.5% to 7.3%.

A borrower with a $500,000 mortgage will now pay an extra $273 a week if they pay it off over 30 years. That’s why economists and borrowers are keen to pick where interest rates will go.

One way you can get a sense of where interest rates may go is by looking at the Reserve Bank’s Official Cash Rate track. This is the Reserve Bank’s forecast of where they may take the OCR in the future.

If the OCR falls fast, then banks will decrease their mortgage interest rates quickly. If the OCR stays high, mortgage interest rates will remain higher for longer.

The OCR track comes out every three months and has been released consistently since 2016.

Currently, the forecast suggests that the OCR won’t fall substantially until mid-2025. But does the Reserve Bank always do what it says it will do?

To find out, I’ve taken the bank’s forecasts and compared them with what the Reserve Bank actually did.

Within six months, the bank tends to stick to what it said it would do. At that point, they are usually within 0.15% of their forecast.

But over time, the bank deviates further and further away from the OCR track. After a year, on average, they’re 0.8% away from what they said they’d do.

To put that into context, if the bank says that in a year’s time, the OCR will be 3%, half the time the OCR will be between 2.2% and 3.8%.

This is exactly what the Reserve Bank should be doing. Its goal is to tackle inflation, keeping it between 1 and 3% in the medium term. That should be easy to do, except for the fact that new things happen every day.

Since 2020, we’ve had a pandemic, runaway inflation and floods. We’ve had immigration stop, start and explode.

The Reserve Bank needs to weigh up all the factors and then respond. So it’s unsurprising that the Reserve Bank changes course as new facts emerge.

That’s why the Reserve Bank dropped the OCR in 2019 and 2020, even though the year before, it said it would increase it.

In mid-2022, it quickly raised the OCR to 5.5%, even though it previously forecast a peak of 2.6%.

If the Reserve Bank stuck to its guns, blindly following its own forecast, we’d criticise it for not being adaptive. So the fact that it changes tact isn’t surprising.

But, while unsurprising, this number crunching is interesting when we apply it to the Reserve Bank’s current forecast.

The Reserve Bank says it’ll keep interest rates high all year. But the money markets are pricing in significant cuts. They think the Reserve Bank will reduce the OCR faster than the bank is currently saying.

Could that happen? Yes. If the Reserve Bank’s record holds, the OCR could be between 4.9% and 6.4% in a year. Right now, the OCR is more likely to fall than increase.

So, there is a good chance that the Reserve Bank will throw out its forecast and bring down the OCR sooner than expected. But it will only change tact if the right new facts emerge.

It’ll want to see inflation coming down and coming down fast. If inflation falls faster than expected, the OCR will come down quicker than the Reserve Bank currently says. If, on the other hand, inflation sticks around, the Reserve Bank’s current track becomes more likely.

The next inflation data comes out next week on January 24. According to its most recent forecast, the Reserve Bank thinks inflation will fall to 5%.

But, if inflation comes out lower than that, or if the economy remains weak, the Reserve Bank is likely to change course, and bring the OCR down sooner than what it’s currently saying.

That’s good news for interest rates, borrowers and the housing market.

- Ed McKnight is the resident economist at property investment company Opes Partners