I received a bit of a surprise recently when someone said that they were not happy to discover how much it would cost them to borrow money to buy a house in New Zealand. Considering that our mortgage rates are at record lows it seems unusual that someone would consider rates to be a problem.
But then it was pointed out that they were comparing our rates with those in the United Kingdom. The NZ two-year fixed mortgage rate ranges from 2.29% to 2.49% but in the UK it sits roughly 1.2% to 1.4%. So, the NZ rate is about 1% more.
This difference will of course generate quite a different ratio of interest expense to income than in the UK, especially as banks do not work out the ability of a borrower to service a mortgage using the rate they actually borrow at.
Instead, they typically use a rate closer to 5 – 6%. Why? Because no-one has demonstrated any acceptable ability to accurately forecast interest rates anywhere around the world since 2007 and there is not much to suggest that prediction accuracy will improve.
We are still facing a global pandemic, governments and central banks are taking emergency economic measures. And we are seeing shifts in household behaviour which are surprisingly strong and which may or may not continue, and if they don’t (e.g. buying spas and pushbikes) we don’t know by how much the pullback from boom spending will be for different items.
Therefore, although central banks are at pains to stress that they intend keeping their overnight interest rates at current low levels for the next 2-3 years, it is not hard to imagine circumstances conspiring to force them to move rates up sooner than that.
History tells us that printing money can easily generate inflation if people choose to borrow and spend the extra funds sloshing around in the banking system. In New Zealand for instance the money printing since March last year has resulted in banks having almost $55bn on overnight deposit with the Reserve Bank whereas before the pandemic deposits had averaged just $13bn per night.
If banks choose to lend the money and people choose to borrow it, then a surge in economic activity and inflation could easily ensue. But this did not happen in the United States or other countries which engaged in money printing during and the following the 2008-09 global financial crisis, so it seems hard to imagine it happening this time around.
And that is where the considerable uncertainty lies. Our economic models failed to predict the GFC or what would happen after, and no miracle has just occurred to improve modelling accuracy.
Therefore, when it comes to lending, for banks nowadays it is all about having big buffers in case unpredicted things happen.
At this stage, there is in fact nothing strong to suggest that inflation will surge and interest rates rise firmly. Nonetheless, there is an element of danger here for people shifting back to NZ and taking out a mortgage, or arranging a mortgage and property purchase before returning.
Your big risk is that you gasp at the level of NZ mortgage rates compared with UK rates, and decide you will fix one-year solely because that is the lowest rate available and your subconscious mind is telling you you’ll feel better if you get a rate as close as possible to what you could get in the UK.
Most Kiwis already here are following the same route and just fixing one year – because that rate is the lowest. But medium to long-term wholesale borrowing costs are rising, assisted recently by anticipation of a large fiscal stimulus in the United States and accelerating growth once vaccination gets close to producing herd immunity.
The period since 2009 has been one of continuing, persistent, downside surprises to inflation and interest rates. But eventually, these surprises will turn, and as they slowly do, as is happening now, medium to long-term mortgage rates will start rising well before a central bank even talks about one day raising its overnight cash rate.
All this adds up to is this. Be careful about fixing 100% of your mortgage for just one year with a plan to stay rolling for one year terms from here on out. New Zealand has a history of interest rate volatility and community thick skins when it comes to interest rates eventually rising. That is, we tend to ignore rising rates and keep buying things, thus causing our central bank to keep pushing rates higher and higher.
Can we reasonably predict when this might happen? Not at all. No chance. But it has happened before, it might again, and perhaps recognising that means it would be a good idea to have some portion of one’s mortgage fixed at a record low 2.99% five year rate as a partial hedge against goodness knows what the next half a decade may bring for us.
If you want much more information on the NZ economy you can sign up for my free Tony’s View weekly at www.tonyalexander.nz
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