Borrowing strategy

There were no surprises in last week’s Reserve Bank interest rate review. The Overnight Cash Rate (OCR) was increased 0.25% to 3.5%, the fourth successive increase in 24 weeks. Major trading banks have followed suit by adjusting their variable mortgage rates accordingly.

As expected the Governor, Graeme Wheeler, made it known that further interest rate hikes were unlikely at least until the end of the year. That pause will create some stability in the interest rate market and, more importantly, create a window for the Bank focus its attention to the value of the kiwi dollar.

That attention started with Governor Wheeler jaw-boning the kiwi dollar lower by saying; “With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall”.

The impact was immediate – the kiwi dropping from US87 cents to around US85.8. This was largely because foreign exchange dealers took the comments to be a signal that the Reserve Bank would actively intervene in the forex market to bring the rate down if required.

There does appear to be fundamental shift in market expectations about the future of the kiwi dollar, leading most forex commentators to speculate that the general trend into the immediate future is likely to be down.

That’s great news for exporters, especially farmers who have already been hit with a substantial drop in international dairy prices. However, it will be bad news for most, especially consumers, who have benefited from cheaper import prices. The most visible sign will be at the petrol pump. Despite the higher dollar the full benefit has not flowed through to petrol pump prices because of central government increases in petrol taxes. Expect import prices, and the price of petrol, to rise shortly.

In terms of borrowing strategy for property owners, the ANZ make the following comments in its latest Property Focus publication.

“Despite the ‘flattening’ in the mortgage curve, which makes it relatively less expensive to fix for longer terms, heavy discounting of the 2 year…still makes it a very attractive proposition. The 6.09% rate (for borrowers with at least 20% equity) is 0.25% higher than it was a month ago, but it is still well below the floating rate, and significantly lower than the 18 month and 3 year rates. As was the case a month ago, it is not the cheapest rate. But it’s only slightly higher than the cheapest rate, and as its term is 4 times longer, that seems a small price to pay in a rising interest rate environment.”

On the subject of fixing for longer terms, they state, “For those looking to fix, the question is, as always; is it worth opting for a longer term, especially with the 5 year rate now at its lowest level this year? In our view, the short answer is that it is unlikely to be worth fixing for longer…the 2 year and 3 year need to rise by +1.72% and 1.20% over the next 2 years for one to have been better off fixing for 4 and 5 years respectively. That’s a stiff jump in rates given that the RBNZ has already delivered three [now four]OCR increases, and given our expectation that the next few years will be punctuated by pauses in the rate hike cycle, not an ongoing series of back-to-back hikes. We are also mindful of wider considerations such as the moderation in housing, falling dairy and forestry prices, the lack of an inflation smoking gun, and the high NZD.”

So, in summary, the best strategy is likely to be locking in the 2 year rate for those who want to fix, while those who prefer short-term flexibility should consider fixing for 6 months. The variable rate would suit those intending to repay their mortgage within the next few months. As always, it may make sense for a borrower to split their debt into a range of fixed and variable rate terms to better match their principal repayment expectations.

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