Thursday, January 26, 2012

Frank Newman: Interest rate decision becoming clear

Some clear signals about interest rates are now emerging, making the decision a little easier for those wondering whether to “fix” their floating rate mortgage. At present about 60% of all mortgages are on variable rate which, according to the ANZ, rises to 84% when fixed rate mortgages maturing within the next year are added. This they say is the highest proportion of short-term mortgages since the early 1990s.

With respect to the merits of switching variable rate loans to fixed rate, they say, “Recent falls in fixed mortgage interest rates have significantly added to the appeal of fixing, with almost nothing separating carded floating, 1 year and 2 year rates. Certainty has therefore just become substantially cheaper. With the OCR unlikely to go lower, it is difficult to imagine the overall term structure of mortgage rates falling much further, suggesting there may be merit in fixing. However, this needs to be weighed up against floating rate discounts that often come up, which may make remaining floating more attractive for a little longer yet.”

This is consistent with the commentary from the Reserve Bank today when they announced the overnight cash rate would remain at 2.5%. Bank Governor, Alan Bollard, said, “World prices for New Zealand’s export commodities have remained elevated but the recent appreciation of the New Zealand dollar is reducing exporters’ returns. The European debt crisis has also increased the cost of international funding, which will likely pressure funding costs for New Zealand banks over the coming year….”

The spread between the variable and fixed rates certainly has tightened up in recent months. In the case of the ANZ there is virtually no difference (0.05% only) between the variable and 3 year rates, which in effect means there is no cost to lock in interest rate certainly. The only “risk” is that interest rates may fall, although as the ANZ suggests, this is not considered likely, and confirmed by Dr Bollard’s comment that there will be pressure on the funding cost of New Zealand banks over the coming year.

Interestingly in the case of the ANZ and Westpac it is actually cheaper to borrow money on 6 and 12 month terms than variable.

The ANZ say interest costs could rise “… if things get really nasty overseas… However, this is not our core view, and in fact, we must admit that we have been pleasantly surprised at how constructively markets have handled major surprises recently, like news that S&P had downgraded 9 European sovereigns… The point is markets are expecting the worst already, so things have to get really ugly if full-blown panic is to set in. We are also mindful of local considerations, and ironically, the very fact that fixed mortgage rates have fallen without the OCR coming down takes the heat off the RBNZ to cut the OCR.”

About New Zealand’s potential the ANZ say, “NZ ranks 8th in the per capita natural resources stakes globally, a few notches higher than Australia, who are often deemed the lucky country.... You wouldn’t want one area of strategic excellence such as mining to undermine another such as tourism, so sensible regulatory heads are required. However, just like successful businesses need something in their offering that is “different”… the same applies for a nation. New Zealand has this in spades and it’s critical, for the more you pull an income-generating lever, the less pressure there is for austerity, and the better the prospects are for spending sectors of the economy, including housing.”

They make good points. Extracting resources avoids the pain of austerity and this need not be at the cost of tourism. As an example we need simply look to Australia and how they have booming mining and tourism industries.

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