Outlook murky for interest rates as biggest bank slashes predictions

Friday, 21 December 2018

Bank economists don't fully agree on what might lie ahead.

Home loan borrowers may have felt a spark of hope at news that ANZ's economics team now expects the official cash rate to drop to 1 per cent by 2020.

At present it sits at 1.75 per cent, which is already an all-time low.

But how likely is that prediction, and what could it mean for your home loan?

WHAT IS THE OCR, ANYWAY?

The official cash rate is set by the Reserve Bank.

It determines the price at which banks borrow money in New Zealand.

It isn't the only thing that determines the rates you pay on a home loan - that's also influenced by how much it costs banks to borrow money they need from overseas, and what they have to pay to persuade other retail customers to put their money in the bank.

The official cash rate isn't the only thing that sets the cost of your home loan.

Mortgage rates have lifted slightly in recent weeks but are also cheap by historical standards. The median floating rate across the market is now 5.89 per cent, for one year it's 4.55 per cent and two years 4.69 per cent.

HOW LIKELY IS IT TO DROP?

BNZ chief economist Tony Alexander said he thought the odds were against ANZ's prediction coming true.

'But we shall monitor developments offshore, in particular.'

Infometrics chief forecaster Gareth Kiernan said the ANZ prediction was an understandable call but he, too, was unconvinced.

'They are putting a lot of weight on concerns about global growth, and downplaying the inflationary risks associated with the tight labour market and squeezed business profitability,' he said.

'Weighing up the net effects of those conflicting influences on the outlook for the official cash rate is, of course, a matter of judgment, and we believe that the inflationary risk is more important at this stage – although we're not picking rate rises to start until early 2020. If the global growth risks do materialise, I'd think the bank would need to be cutting before the end of next year.'

Satish Ranchhod, at Westpac, said he expected the cash rate to remain on hold until 2020.

The pick-up in inflation was contained enough not to require a cash rate hike, he said, and the economy was ticking along to the extent where a rate cut was not needed.

The Reserve Bank itself has said an increase in late 2020 is the most likely scenario.

WOULD A CUT MEAN LOWER INTEREST RATES?

Either way, no one was sure that a drop in interest rates would mean much cheaper mortgages.

Alexander said some decline in retail interest rates would be expected if the cash rate moved, but that would be influenced by overseas bank funding costs, and the proposal to require New Zealand banks to hold more capital. That is predicted to increase the cost of borrowing.

Kiernan pointed to the 2016 experience.

Then, some bank rates actually increased as the cash rate was falling from 2 per cent to 1.75 per cent.

'Given that ANZ has highlighted global liquidity risks and proposed Reserve Bank bank capital changes as two of the factors behind its change in outlook, I would be even more confident of little or no response in the floating mortgage rate, as both these factors would tend to put upward pressure on banks' funding costs.

'At best, any drop in the cash rate would probably offset this upward pressure and see retail rates hold steady. However, given the lack of pass-through previously in 2016, it's possible the Reserve Bank cuts wouldn't even manage to prevent the floating mortgage rate rising due to these other factors.'