Normalising interest rates

There’s been a lot of emphasis on mortgage interest rates lately and for good reason as they seem to be ever increasing … but what’s normal?

According to graphs from the Reserve Bank, going waaay back even before Marty and Doc’s day in 1985, through most of the 1960’s variable mortgage rates were steady around 6.5% while the 1970’s started around 7.5% and increasing year on year to come out at 13% in 1980 and then increasing again to peak around 21% in 1987 and finishing at 15% in 1990 then steadily decreasing down to 7.6% in 1994 and up and down between 11% and 6.5% for the rest of the decade settling on 6.5% in March 1999 when the Official Cash Rate ( OCR ) was introduced by the Reserve Bank as a Monetary Policy tool to influence the level of economic activity and inflation … whew!

Cracking into the new millennium with variable rates around 7.6% in Jan 2000, in Oct 2003 exactly 20 years ago we were around 7.0% in a booming economy then rising about 1% a year to come out in July 2008 at 10.9% since the Reserve Bank had introduced measures to slow the then booming economy by increasing the OCR.

On the back of the GFC we then went from floating rates of 10.9% in July 2008 dropping to 6.3% in March 2009 then floating between around 6.5% and 5.5% for the next 10 years to Jan 2020 then Covid struck.

Interestingly the OCR, introduced in March 1999 at 4.5%, essentially as an economic dial to wind the economy up and down made its way to 6.5% in Jan 2005 and by July 2007 had been cranked up to 8.25% in a bid to slow the booming economy where it stayed to June 08 which by then the GFC had hit, then was progressively dialled back to 2.5% in July 2009 where it pretty much stayed for the next 7 years to June 2016. From there it went even lower and was incrementally dropped to 1% in Aug 2019 then when Covid turned up, it was dropped to 0.25% in March 2020 as part of a Covid economic stimulus package where it stayed to Aug 2021 then incrementally climbed 12 times in 20 months to 5.5% in May 2023 where it remains.

So in line with the OCR, interest rates have climbed post covid from floating rates of just under 4.5% in Oct 2020 to around 8.5% now in Oct 2023 with fixed rates a percent or so behind … and about 2.5 - 3% above the OCR.

The thing is, looking at the above, since Covid, when rates were determinedly and briefly set at record lows, we’ve not gone anywhere we haven’t been in the last 20 years, in fact not even that far.

So what’s normal ?

Considering in the 1960’s variable rates were around 6.5% for much of the decade, let’s just time warp through the crazy 70’s 80’s and 90’s arriving in this Millennium and really, talking about back to the future, around 6% odd is still looking like the norm as its been there for the most part this century outside of having crazy economic factors like rampant economy, GFC and Covid to contend with.

So OCR at 2.5 - 3.5% and floating interest rates at 5.5 - 6.5% would be a realistic norm with inflation back under 3% and we’re back in control again, would be a fair summation by my reckoning and no, we’re not going to get back to the super cheap money that caused the GFC in the US in the first place and later was the result of a pandemic … no thanks, would rather pay a little more and have stability, not to mention the crazy house price swings that go with it.

Covid hangover

So right now, we’re sitting about 2 - 2.5% above what could be perceived as a normal interest rate and that’s understandable because we still have inflation to deal with and immigration to settle which it will do in time so the Reserve Bank is going to try and slow things a bit more until they do.

The word on the street from economists and commentators is the OCR and interest rates will remain where they are for the next year or so, with the OCR likely to start to fall from last quarter of 2024 to first quarter of 2025 so around this time next year and of course, rates are quick to go up with the OCR and sticky on the way back down so don’t expect any decrease in rates for a while after that … so we’re here for likely the next 18 month’s or so before rates start to fall back down in earnest, short of any impending economic upheavals.

It’s an estimation … the dark art of economic forecasting, akin to reading tea leaves … and of course its constantly evolving.

Monetary Policy and OCR announcements

8 times a year, about every 6 weeks, the Reserve Bank releases a Monetary Policy Review and an OCR announcement 7 times a year, the MPR committee having met to consider various factors including domestic and global economic conditions, inflation forecasts and the overall health of the financial system. This will determine where the OCR which influences interest rates, needs to be to effect outcomes, for example a higher OCR will aim to reduce spending and encourage saving in a bid to reduce inflation and a lower OCR will stimulate the economy as we’ve seen post covid … the happy medium being the sweet spot. So they dial it up or down with both lending and savings rates affected and the economy reacts in due course.

The latest announcement happened at 2pm today, Oct 4th and the decision was to retain the OCR at 5.5% citing:

• Interest rates are constraining economic activity and reducing inflationary pressure as required.

• Demand growth in the economy continues to ease.

• Globally, economic growth remains below trend and headline inflation has eased for most of our trading partners.

• While the imbalance between supply and demand continues to moderate in the New Zealand economy, a prolonged period of subdued activity is required to reduce inflationary pressure.

While you and I might think slowing the economy is crazy it’s considered ‘the path of least regret’ by the Reserve Bank as the alternative is rampant inflation. The ‘OCR explained’ link at the end of this article explains that in more detail.

With the announcement being a positive sign going forward it’s not the only factor in determining interest rates.

Market interest rates, particularly for longer terms, are also affected by the interest rates prevailing offshore since New Zealand financial institutions are net borrowers in overseas financial markets. Movements in overseas rates can lead to changes in interest rates even if the OCR has not changed.

Where to from here

Sit tight and hang on. If you have a mortgage coming up for renewal and you were lucky enough to lock in a low rate around 3% … congratulations you would have paid more principal for the same money but you’re going to find its more like 7% now on a 2 year fixed rate but its not the end of the world. Your renewal will give you options where the monthly payments are similar to where you are now, if not a little less, the term however will be pushed back out.

For example for a mortgage at 3% with 10 years left to run the same payments at 7% would push it out to around 13.5 years. Then in a couple of years when you re fix it at say 5.5% it would be about 11.5 years for the same amount ( which would be less by then as well ). You’ve just had the advantage of the last 2 or 3 years at better than normal rates … remembering normal, if that were a thing, would be more like 6%.

If, on the other hand, you took out a new mortgage at the height of covid, on lower rates and when house prices peaked and if say you had an 80% LVR ( min deposit ) … interest rates will have more than doubled, the property worth less than what you paid ( but hold tight, they’re increasing again ) and if you’re already at a 27 year term … then things are a little different for you. Again, its not the end of the world, banks will work with you and on a case by case basis will do what they can to achieve the most suitable outcome. This is why, when you applied, they will have run their test rates at a much higher rate and would have approved it on that basis so when rates did move up that they know you can afford it anyway … and they will typically maintain the valuations as at the time of purchase.

If you do have any concerns in that regard then it’s a good idea to have those conversations early with your bank or financial adviser.

With around 52% of mortgages on fixed rates, this will also mean floating rates should have found their peak and be steady for another year or so before trending downwards and not gone as far as we have seen earlier this century fortunately and far from the heady days of the 80’s thank goodness.

Things are settling, building material supply and pricing is settling and house prices are settled to starting to trend upwards, we’re on the mend.

In summary

Normal also requires no extenuating circumstances to upset the mix … so even if it is achieved it could well be short lived given the crazy world we live in, so maybe our normal is there is no normal after all … given the past 60 years as evidenced above that’s quite possible, it’s been more ‘not’ than what could be considered normal. One thing is for sure … we shouldn’t expect super low rates again for a fair while … not in NZ anyway.

This article is focused on mortgage rates however personal and equipment rates follow a similar pattern for the same reasons, everything’s gone up about 4% from the record lows of a couple of years ago and are now back around pre covid levels … we really are getting back to the future.

Throw in an upcoming election as well and the likely changes that will bring … will be interesting days ahead indeed … just need to play the long game.

Links to Reserve Bank ( RNBZ ) website for information and graphs the above is sourced from -

Mortgage interest rates from 2004 – 2023 -
https://www.rbnz.govt.nz/statistics/series/exchange-and-interest-rates/new-residential-mortgage-standard-interest-rates

OCR rates from inception in March 1999 to now -
https://www.rbnz.govt.nz/monetary-policy/monetary-policy-decisions

Oct 4th OCR announcement - https://www.rbnz.govt.nz/hub/news/2023/10/official-cash-rate-remains

OCR explained - https://www.rbnz.govt.nz/education/explainers/the-official-cash-rate-explained

Remember this is dialogue only and in no way constitutes financial advice and should not be acted on by itself.

Please seek professional advice from a licensed financial adviser such as Infinance who will evaluate and consider your circumstances on a case by case basis.

Thanks for reading this and please feel free to call or email if you would like to make any enquiries re the above.