Mortgage rates: new norm or cyclical?

So we have seen the official cash rate drop and the banks have responded, with some increasing their floating mortgage rate and most increasing their two- to fiveyear fixed rates.

This looks to be a bit of a head scratcher, as the usual expectation would be for interest rates to drop.

In the background, though, the Reserve Bank is reviewing capital requirements for banks, meaning they might have to increase their cash reserves.

If so, the banks may seek to hold on to some of their profit.

One way to do this is not to pass on interest-rate drops to mortgage borrowers. So in the short term banks may be building up their reserves, and mortgage rates will stay relatively high. Once the reserves are in place we could see rates dropping again.

There is also talk, mainly from the banks, of interest rates potentially rising next year. Commentator Bernard Hickey had this to say: ‘‘There is now a growing debate about whether the deflation is structural and linked to changing technology, the globalisation of services and ageing populations.

‘‘For now, central banks think it’s cyclical. The wisdom of crowds in financial markets, particularly bond markets and stockmarkets, suggest it might be structural.’’

Structural deflation could imply this is the new norm, whereby interest rates sit between 4 per cent and 5 per cent. Banks arguing it is cyclical would want to lock you into long-term fixed rates, likely with a greater profit margin than normal.

(As a footnote, New Zealand banks are some of the most profitable in the world.)

Personally, if I was floating at the moment, I would take the one-year fixed rate. It looks to be the lowest advertised rate and the next 12 months should give a better understanding of whether we are facing a structural or cyclical environment.

I would also increase my repayments as much as possible. The less I have owing the less I am affected by interest rates.

Mike Columbus is a founder of sortmymortgage.co.nz and can be contacted on 03 335 3527. This article is an extract from Sort My Mortgage (What Your Bank Doesn’t Want You To Know). For a free copy email info@sortmymortgage.co.nz. This advice is of a general nature only; before acting on it please read the disclaimer which can be obtained via email.