Friday, November 14, 2014

Frank Newman: The good oil on interest rates


Last week the Reserve Bank issued its latest review of the Official Cash Rate (OCR). As expected the OCR remained unchanged at 3.5%.

The last rise was in July. At that time the consensus amongst interest rate watchers was for a rise in the OCR before the end of this year. Now the consensus expects interest rates to remain at current levels until September next year. Some are of the view that the next rise could be even further out.

With annual inflation running at about 1% and the heat coming out of the Auckland property market, there appears to be little need for the Reserve Bank to clutch the interest rate levers just yet. Contributing to the lower inflation are falling oil prices, a weaker global economy, and lower ACC charges.

All this is good news for property owners. Those with fixed rate mortgages coming up for renewal will be able to review their options in stable conditions and at a time when interest rates remain at historically low levels. The October issue of the ANZ Property Focus report has this to say.

"Average mortgage rates offered the 'big four' banks between 1 year and 4 years are slightly lower compared with last month, with the 1 year rate the biggest mover, down 0.2% to 5.86%. The floating rate remains one of the higher rates available. However, intense competition has driven rates between 6 months and 2 years to within 0.01% of each other...floating remains unattractive unless you can secure a substantial discount or intend repaying your loan. Fixing does imply less flexibility, but with rates effectively the same between 6 months and 2 years, borrowers have ample choice when it comes to choosing a suitable tenor that balances cost with flexibility. The question is, is it worth fixing for longer?...for borrowers with 20%+ equity, we see better value in 6 month to 2 year rates, rather than longer terms."

In other words, the two year fixed rate is likely to suit most borrowers at present, with the card rate for most banks being around 5.75% for those with a loan value ratio of less than 80%. Don't forget to shop around for the best rate. There are all sorts of freebies on offer (like cash and large TVs) but the best incentive is the lowest interest rate.

Although we tend to think our finance markets are isolated from the rest of the world, it is interesting to see how something as distant as international oil prices can directly affect property owners here. Part of the lower inflation story that is benefiting borrowers has its origins in fracking and deep sea oil drilling.

In the last few months the price of crude oil has fallen to around US$80, its lowest level in four years. Weak demand from Europe and a substantial increase in supply, particularly from the US, has resulted in supply outstripping demand and therefore lower prices.  The U.S. has overtaken Saudi Arabia as the world’s biggest oil producer (Russia is third).

According to Joel Kotkin, an internationally-recognised authority on global trends, the US energy revival has been sparked by new technologies such as fracking and deepwater drilling. He says, "This has transformed the Great Plains alone into the world’s 14th largest oil producer, roughly on a par with Nigeria and Norway. Unless stopped by regulatory constraints, this expansion may only be in its infancy...".

He goes on to say that this new technology may release trillions of barrels of oil over the next few decades and that the US energy boom could create more than a million industrial jobs over the next decade, both to supply the industry and as a result of lower energy costs. The energy sector alone could drag the US out of its economic slump.

Some are speculating oil prices will go a lower, although in the short-term that may depend on the outcome of the meeting of the 12 OPEC members on the 27th of November. Should the Saudi's not cut back their production there is every chance that increasing supply from the US will flood the world with oil and prices will continue to slide. That would ease inflationary pressures internationally, and in the long-term shift the balance of economic power away from the OPEC nations and Russia.

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