OVER THE WHOLE FIVE-YEAR PERIOD DURING WHICH THE RESERVE BANK LAST BATTLED INFLATION, IN THE 2000s, THE AVERAGE MORTGAGE RATE OFFERED BY THE MAJOR BANKS INCREASED BY 53%. HOWEVER, IN ONLY THE LAST 22 MONTHS IT HAS INCREASED 118%.
The Reserve Bank has charged ahead with OCR hikes without taking proper account of the fallout in the pipeline from the massive increase in interest costs. However, before the Reserve Bank realises it has tightened too much, the market should react to the fallout and deliver some relief in the form of a market-led fall in mortgage interest rates.
In the November Monetary Policy Statement, the most recent one available at the time of writing, the Reserve Bank predicted only a 13% fall in residential building activity over 2023 and 2024. This is much smaller than past major falls of 20-30%. This contrasts with the ANZ survey of residential builders, a useful guide to building prospects, that this has fallen to a new all-time low.
This should be no surprise, given how sharply interest costs have increased. Over the whole five-year period the Reserve Bank last battled inflation in the 2000s, the average mortgage rate offered by the major banks increased by 53%. However, in only the last 22 months it has increased 118%.
The chart shows that it is normal, especially for longer-term wholesale rates like the five-year swap rate, to move up and down ahead of the OCR. Shorter-term rates, like the one-year swap rate, are more closely linked to the OCR but still tend to lead it.
The five-year swap rate is based on what the market expects the OCR to be over the next five years. When news starts to emerge that the economy is growing too strongly, threatening inflation, the market pushes especially longer-term rates up. But with the news likely to be negative over the next year, the market should start to push them down as much as a year before the Reserve Bank reacts to the negative news, with a hint of this in the five-year rate.
Banks adjust mortgage interest rates largely in response to wholesale rates. This offers scope for some relief from OCR hikes this year but only if the economic news is sufficiently bad. However, it is likely to be a somewhat drawn-out battle against inflation, with any relief likely to be only partial.
