Mortgage rates likely to rise

ASB Bank chief economist Anthony Byett gives his opinion on where interest rates might be heading.

Wednesday, February 13th 2002, 11:17PM

An opinion
The usual proviso: what interest rates will be next year or the year after is unknown. Nonetheless, borrowers are regularly faced with the decision about whether to float or fix loan rates and, if fixing, for how long?
The situation will differ for each person.
The following notes put aside these personal issues and offer an opinion about what might happen to loan rates.
Be warned however. Economic events can unfold in many ways and interest rates will respond to each new situation.

The key driving force to interest rates at present is the global slowdown and probable recovery. Short-term or variable rates have been pushed to low levels, especially offshore, to stimulate flagging economies. These cuts will be temporary. The contentious issue, though, is how temporary? Central banks will push short-term rates back closer to the average of recent years when they believe each economy has regained a growth momentum.

Pricing for 2-year to 5-year rates already include anticipations that these moves will come around mid 2002. If correct, the issue then becomes how high will central banks push short-term rates?

There is the chance, though, that the economic recoveries expected in the US and elsewhere do not emerge, at least not until later in the year or until 2003. In this case, short-term rates could stay lower for most of 2002 and 2-year to 5-year rates could actually decline slightly.

At this stage, the more probable scenario is global recovery and higher rates. It is not unusual for the variable home loan rate to rise around 1-2% in the early and middle stages of an economic growth surge. That is, the ASB Bank Variable Home Loan rate could well be in the 8-9% region (ie: close to the long-term average) by the end of 2002.

Hence, two generalisations follow from these thoughts:

* with rates generally low, there are good opportunities for fixing rates for 2-5 years;

* and with rates likely to increase early 2002, fixing now rather than later may be prudent.

The following graphs and comments highlight some of the key trends and factors with 1, 2, 3 and 5-year ASB Bank fixed home loan rates.

The 1-year fixed rate, although higher in recent weeks, is low. Rates above 7.0% are more the norm. The current low 1-year rate is a direct result of slow global growth. ASB Bank economists believe that economic pickups are imminent and that interest rates will rise.

Advantage of 1-year: low rate for next 12 months; opportunity for low rate next year also if global recession prolonged.

Disadvantage: a quick economic recovery however will mean higher rates after fixed term.

The 2-year rate is priced consistent with a modest New Zealand growth phase in late 2002.

ASB Bank economists are picking a rapid growth phase in New Zealand from mid 2002.

Advantage of 2-year: low rate locked in for 2 years.

Disadvantage: missed opportunity for lower rates should economy worsen; but also risk of higher rates after fixed term if eventual pickup is rapid.

Also relatively low, the 3-year rate prices in economic growth but not necessarily much chance of strong New Zealand growth.

ASB Bank economists suggest strong New Zealand economic growth is a distinct possibility.

Advantage of 3-year: lock in low rate through probable period of rising interest rates.

Disadvantage: missed opportunity should global and local economies worsen and rates fall again.

Fixed 5 year rates have typically offered good value on the occasions that they are below 8.00%. Rates at present at close to this mark, suggesting the 'bargain' levels have gone.

The key advantage - surety for 5 years - however still remains.

Disadvantage: missed opportunity if rates do decline further or remain low for some years; a higher early repayment fee should rates decline.

The last word: nobody knows the future. The above notes hopefully help with the decision about fixing loan rates. They at least provide an historical and economic perspective to your decision. They do not, unfortunately, indicate what will happen.

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