The interest rate worm has turned

The interest rate worm has turned, according to the latest ANZ Bank Property Focus Report. Their commentary signals a significant shift in the way the Bank sees things heading.

With respect to mortgage strategy they say, “Although the OCR has been cut by 25bps, this merely offset a rise in funding costs, and as a result, no banks have cut their floating mortgage rates. Rises seen for some longer-term fixed rates reflect both higher funding costs and the sharp rise in wholesale interest rates that has occurred since August. We believe mortgage rates have seen their lows, and although there is real pressure for them to rise further, we caution that rises are likely to be gradual. Nonetheless, given how flat the mortgage curve is, for the first time in a long time we believe it is worthwhile considering fixing some portion of your mortgage for longer than 1-2 years.”

The shift here is that they no longer believe mortgage rates will decline. That means the time is right to switch from 1 to 2 year fixed rate mortgages to 3 to 5 year terms.

Part of the reason for the worm’s change in direction is the fundamental shift going on with government policy in the US. President elect Trump has signalled he wants to make America great again by spending up large on infrastructure projects. That will invariably push up interest rates in US and that will flow through to the cost of money internationally. In New Zealand banks rely on overseas money to fund their lending so if the cost of money goes up, they must increase their lending rates to recover that cost.

They also sounded a warning about house prices. They said, “Another key financial stability risk is housing affordability; it is absurd, particularly in Auckland. Auckland house prices trade at a multiple of 9½ times incomes and first home buyers buying the median-priced house on typical terms now have to commit half their after-tax income to meeting minimum mortgage payments. That is not much room to move in the case of unexpected developments, whether that’s ill health, job loss, pregnancy, divorce or any of the other curve balls life can throw, let alone highlighting the sensitivity to the possibility of higher future interest rates.”

There is a fundamental problem with low interest rates. It’s the same problem that arises when booze is free – people consume too much and the consequences are not pretty. Those who have filled their pockets with cheap money and lived the high life will come badly unstruck when interest rates rise, as they inevitably will. For them, the good times will be over – savers will be able to pick up their assets at a discount. The worst will be in Auckland.

On the positive side, the New Zealand economy is strong. It was surprising to hear the Prime Minister talk about future growth as being like a “Hockey stick”, a term usually used by global warming alarmists to describe runaway and catastrophic climate change. Clearly the PM is pretty bullish about the state of the government’s books, so much so that he thinks increased government spending, debt repayment, and tax cuts are all achievable in the future.

Another positive is the strong rise in population numbers. It’s a truism that property prices follow people so if you can pick population movements you can pick property prices. The ANZ say, “Migration flows to and from New Zealand are one of the major drivers of housing market cycles. The early-1970s, mid-1990s and mid-2000s booms coincided with large net migration inflows. On a three-month annualised basis, net permanent and long-term migration rose to a strong 72,700 in October, which is around 1½% of the resident population and at all-time highs…We are not expecting annual net inflows to ease back to the long-run average of around 15,000 any time soon. Due to its economic out-performance, perceived safety and political ructions elsewhere, New Zealand will remain an attractive destination for migrants.”

So now is the time to think about the property and money markets entering a new phase. As always, we don’t know how quickly things will move but now is the time for risk averse investors to exercise some caution. Interest rates are likely to be entering an up cycle while property prices are showing signs of flattening out.

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