Wednesday, 22 February 2017

Are interest rates really biting?

"Increasing mortgage interest rates", the Reserve Bank said on page 18 of its latest Monetary Policy Statement, "combined with a tightening of loan-to-value ratio (LVR) restrictions in late 2016, have contributed to a slowing in the housing market".

Moderating the heat of the housing market may be welcome - though previously low interest rates are far from being the only thing that's been inflaming the market - but otherwise I got a bit worried that higher rates might be crimping the economic outlook. If the average or marginal household is now carrying a bigger mortgage, and mortgage interest rates go up, the impact on already cramped family budgets could see unpleasant things happening (via consequent necessary cutbacks in household spending) to the currently strong state of the economy.

And then I thought, hang on a sec. Yes, it's true that some mortgage interest rates have started to increase. The chain of events is, US bond yields have risen, especially after Trump was elected; NZ bond yields and other local long term interest rates have gone up as well (they tend to track the US rates plus a credit premium); and this has fed through with a lag (via higher funding costs for the banks) to higher fixed mortgage rates. The graph below shows the past year's trends for some of these rates*. Rates bottomed out around the middle of last year and have risen a bit since.

But how much these increases have been contributing to a slower housing market (or indeed slower anything else) is debatable. The first time borrower may be finding it slightly tougher going. But for existing borrowers, most folks these days are on fixed rates - at the end of December last, there were $182 billion worth of fixed rate mortgages compared to $53 billion of floating rate - and they won't have noticed anything, because they haven't come to the end of their existing fixed rate arrangement.

And then I wondered, well, what happens when they do roll over from their existing fixed rate? Will they roll over into something that will have the household worried about how to balance its books?

Quite the reverse, actually. Here's what a borrower who took out an x-year fixed rate mortgage x years ago would pay to roll over into another x-year fixed rate mortgage today (or at least at the end of December, the  latest available RBNZ data, though today's rates are very similar).

Other than for the 1-year fixed rate, where it's effectively the same, the household with an expiring fixed rate mortgage will be rolling over into a lower borrowing cost for another mortgage of the same maturity as before. Large falls in fixed rates in recent years dominate the small increases in the last few months. For most borrowers in coming months, the mortgage rollover will boost disposable income, not restrain it.

There's also the possibility, though, that local fixed rates will keep on rising and upset the calculation. Let's suppose that US interest rates rise by 0.5% during the course of this year (roughly in line with what the latest, February, Wall Street Journal poll of US forecasters expects for US 10-year yields). And let's assume all local rates rise by the same amount. By the end of this year, 3-, 4- and 5-year fixed borrowers would still be rolling over into cheaper loans, but 1- and 2-year borrowers would be paying a bit more, as would first time borrowers. Overall, this wouldn't represent a big squeeze (or possible any squeeze) on household budgets.

So I'm inclined to think that rising mortgage rates will not be any near-term threat to the economic outlook, and somewhat unconvinced that they can have have played much part to date in a slowing housing market. There may be other reasons for a national cyclical slowdown - the latest BusinessNZ/Bank of New Zealand survey of manufacturing had a hint of the construction sector hitting capacity constraints, though on the other hand the equivalent survey of services showed there is still "swift, broad-based, growth occurring in the services sector" - but interest rates, to date, don't look like much of an actual or potential brake.

*Local fixed rate mortgage rates come from the RBNZ's site, but they're not where might think they are (you'd likely expect in 'Statistics', 'Exchange and interest rates', 'B3: Retail interest rates on lending and deposits'). However you can find the full range of fixed mortgage rates in 'Statistics, 'Registered Banks', 'S8: Banks' mortgage lending ($mn)'; they're in section E6. For the very latest rates, if you go to the bottom of the 'Mortgage Rates Table' in the 'Mortgages' part of the Good Returns website, you'll find the up to date median floating and fixed (1,2 and 3 year) rates.

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