The brutal truth about looming interest rate rises
If you can’t handle your mortgage rate rising 1.5%, you’ll have a problem when restraints are put in place.
The level of mortgage debt in New Zealand when interest rates were last at a peak in the middle of 2008 was $159 billion. Now mortgage debt stands at almost $310bn.
Allowing for principal repayments we might be able to say that new debt from mid2008 forms the overwhelming majority of mortgage debt now. This will be especially so when we consider the 150% rise in average house prices since then requiring bigger average mortgages.
Most borrowers have never seen a sustained monetary policy tightening cycle as happened from 2004 to 2008. Some borrowers will have experienced the 0.5% rise in the Reserve Bank’s official cash rate in 2010 – which was quickly followed by a 0.5% cut in 2011.
Some will have experienced the 1% rise over 2014-15 – which was then followed with five years of cuts amounting to 3.25%.
When our central bank starts raising its official cash rate perhaps early next year, then keeps raising it, a lot of people will experience something they have never felt before – fear of rising borrowing costs and worries that they will go higher. They will start to get angry at their bankers who will inform them that fault lies with the Reserve Bank. So they will get angry at them.
Will the Reserve Bank care when stories start emerging of some people no longer being able to service their mortgage? Will they care when young people say that the combined effects of previously soaring house prices and rising interest rates mean they can’t afford to buy a house?
The Reserve Bank will care just as much for these people as it did for the groups negatively affected by monetary policy tightening cycles in the past. Zero. Their job is not to guarantee an ability to purchase a house or to service a mortgage, but to keep inflation between 1% and 3%, avoid instability in the economy, interest rates and the exchange rate, aim for high sustained employment, and aim also for the undefined concept of sustainable house prices. They will show as much concern as they did when farmers and other exporters were badly affected by a soaring NZ dollar caused by high interest rates in previous tightening cycles.
Even if a young person reading this accepts that it is not the central bank’s job to care but to follow its remit, they may not truly understand why it is necessary to punish some groups in order to stop a little rise in the inflation rate. Some understanding can best begin by realising this.
The only reason interest rates have been so low is because our central bank was fighting the feared effects of a global pandemic which could have pushed the world into a new Depression. That scenario went off the table a long time ago and instead the RB’s actions have caused a 30% jump in house prices which has already made getting on the property ladder extremely hard if not impossible for many people.
The policy cost of fighting Covid-19 has been borne by new-home buyers. There is no need for super-low interest rates now so the RB need to remove them.
Second, there is no longer the downside risk to inflation and collapse in business and consumer sentiment which encouraged the Reserve Bank to cut interest rates 0.75% between May and August of 2019.
Back in 2019 the net proportion of businesses saying they planned hiring more people was just 6%. Now the proportion is 18%. The net percent planning investment was 4%. Now it is 15%. Back then the inflation rate had fallen to 1.5% and we’d just had two quarters of only 0.1% rises.
The RB feared inflation falling below 1%. Now, inflation is 1.5%, the last two quarters were 0.5% and 0.8%, and a rate near 3% beckons.
So, the Reserve Bank also needs to take away the special stimulus they applied in 2019. Add the 0.75% cut in the cash rate then, to the 0.75% cut last year, and you get 1.5%. That is exactly equal to the rate rise projected by the RB for the two years starting next year.
All they plan at this stage is removing stimulus – not applying restraint. If you can’t handle your floating mortgage rate or one-year fixed rate rising 1.5%, you’ll have a major problem when actual restraint needs to be applied.
“Will the Reserve Bank care when stories start emerging of some people no longer being able to service their mortgage?”