COMMENT: If you’re one of the many New Zealanders with a mortgage, you’re probably worried about what’s going to happen to interest rates over the next couple of years.
Less than a year ago, we were all marvelling at how low interest rates were, and we wondered whether or not one-year fixed rates of less than 2% would be the new normal. Now, most one-year rates are sitting between 5% and 6%, and are all but certain to rise over the next 12 months.
What happened? Did the Government finally find a way to tackle house price inflation by increasing the cost of money? Or, did the Reserve Bank take seriously the Government’s directive that it should “consider house prices in its policy settings” and act decisively to bring those prices down?
Actually, the increases had nothing to do with either of those things. They’re entirely due to the way that the Reserve Bank responds to inflationary pressures within the economy and the tool that they use to get inflation under control.
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Let me explain.
Prior to the 1990s, governments here and overseas could, and did, use monetary policy as a way to tinker with economic settings and curry favour with voters prior to elections. The consequences of this, particularly throughout the 1980s, were disastrous. It led to massive inflation, high interest rates, and the extreme erosion of the purchasing power of money – which also fuelled exorbitant wage demands from unions. The result was huge damage to international economies and a determination to address it.
In New Zealand, the solution came in the form of the passing of the Reserve Bank Act, by the then Labour Government, in 1989. This ground-breaking piece of legislation made the Reserve Bank of New Zealand independent and removed from governments the ability to interfere in the monetary policy of the country. It also allowed them to use the Official Cash Rate (the OCR) as a tool by which to increase or decrease interest rates so as to keep inflation within a range (currently, 1 to 2% per annum). When inflation looked like it was increasing the Reserve Bank could increase the OCR, thus increasing mortgage interest rates. This had the effect of reducing discretionary spending because more household and business income had to be directed to the payment of mortgages and loans, meaning less was being spent on other inflationary activities and goods.
Ashley Church: “Less than a year ago, we were all marvelling at how low interest rates were.” Photo / Ted Baghurst
The tool has been extremely effective at bringing inflation under control. However, in recent months inflation has been climbing and currently sits at just under 7%. Some of this inflation was due to international pressures, but a big portion of it was the result of excessive spending by an out-of-control Government which appears to have no understanding of the extraordinarily damaging and inflationary consequences of its wasteful spending.
The Reserve Bank acted swiftly. It has already raised the OCR from 0.75% to 2% this year alone – and has indicated that it will continue to do so until, probably, the middle of 2023. This is why bank mortgage rates have gone up (although, if you do the math, it’s hard not to conclude that the banks are also profiteering from this situation as the increases exceed the OCR increase by some margin).
So how much higher could interest rates go?
As recently as May, the Reserve Bank was predicting that the OCR would go to 3.9% by June of next year – however, in a more recent interview, Reserve Bank Governor Adrian Orr suggested that they may not go that high if the Reserve Bank gets inflation under control sooner.
For home-owners and investors it means that mortgage interest rates will continue to go up but that there will be an end to the increases next year, provided inflation is tamed. For now, it would be wise to budget on the expectation that one year mortgage interest rates could conceivably get as high as 7%.
Beyond that, we don’t know what will happen, but Orr has also suggested that he would like to bring those rates back down again “over time”. How long that “time” will be is anyone’s guess.
- Ashley Church is a property commentator for OneRoof.co.nz. Email him at [email protected]
