How high will interest rates really go?

New Zealand’s official cash rate (OCR) is tipped to hit its highest level since 2016, as the squeeze goes on mortgage-holders.

But what does that mean for the rate that home loan borrowers pay?

Many bank economists expect the Reserve Bank will announce another “double hike” in the OCR later this week, raising it from its current level of 1.5% to 2%, which would be the highest it has been since September 2016.

At that time, the average standard two-year rate advertised by banks was 5.06%, according to the Reserve Bank’s data.

READ MORE:
* Economist says interest rate outlook has not changed despite Ukraine war
* How high will interest rates go in 2022?
* Don’t expect lockdown to stop mortgage rate rises

This week, the main banks were advertising standard (non-special) two-year rates of 5.85% to 6.19%. Special rates were between 5.19% and 5.25%.

The main reason that we are already paying more for our home loans is that further increases are being priced in by the financial markets.

In September 2016, the 90-day bill rate was the same as it was on Friday – 2.23% – but the 10-year bond rate was 2.39%, compared to the average of 3.7% so far this month.

That means, economists say, that while the OCR might still rise another 1.5 to two percentage points before its peak, that doesn’t mean we can expect more dramatic home loan increases from here.

“The last time that the OCR was at 2%, the Reserve Bank was projecting that it would fall to 1.75% and stay there for the next two years (which actually turned out to be right),” said Westpac’s acting chief economist Michael Gordon.

“It’s that forward track for the OCR that really matters for term interest rates – you can even think of it being the Reserve Bank’s second policy tool.”

So how much further will they go?

Jarrod Kerr, chief economist at Kiwibank, said he expected two-year rates to increase to more like 6.5%.

“All mortgage rates on offer are likely to lift from the current levels of between 4.4% to 6.9%, to 6% to 7.5% over the coming year. More than 60% of outstanding mortgages are either floating, or rolling off fixed rates this year.”

NZIER principal economist Chrstina Leung said floating rates would likely peak at 7% over the coming years, compared to 5.5% at most banks now.

At Infometrics, Gareth Kiernan said he expected floating rates to peak at just over 7% and the cheapest available to hit about 5.4%. That is currently 4.55% on one year.

“We expect all of these peaks to occur in early 2023. Although there’s still uncertainty about where the OCR peaks at, the slowing economy and downturn in the housing market are probably now reducing the upside risks for the OCR (which we expect to peak at 3.25%). It’s less certain where long-term wholesale rates are headed, and I’d argue that further increases in ten-year bond rates towards 4% could create upside risks on the one-and two year rates of as much as 40 basis points on the forecasts above.”

Gordon agreed fixed-term mortgage rates are close to their peak for this cycle, particularly for the longer fixes.

“The reason is that – up until very recently – financial markets have been betting on the OCR reaching a peak of as much as 4.25% in the next two years. That feeds into banks’ funding costs over say a two-year horizon, and in turn affects where they set retail lending and deposit rates.

“A 4.25% cash rate is a lot higher than what the Reserve Bank (and bank economists) think will be necessary. That implies that financial markets are already anticipating some fresh bad news on the inflation front, beyond what the Reserve Bank already expects. So even if we do get that bad news, it doesn’t leave much room for term interest rates to go higher than they already are today.”

What’s the best strategy?

It’s always easiest to spot the deals in hindsight and if you fixed for five years in 2021 at a rate of 2.99% you’d probably be feeling pretty smug.

Now, the opportunity to fix and beat the increases has probably passed but if you’re worried about rising costs, some certainty probably has value.