Will fixing become normal again?

When fixed-rate mortgages became so popular, the interest rate environment was very different from today. Jenny Ruth asks whether we are going to return to our old ways or will home loans follow international norms.

Wednesday, September 7th 2011, 8:41PM

A big determinant of whether the tide turns again and we rush back into fixed-rates is whether our interest rates return to their previous pattern.

Back then, short-term wholesale interest rates, on which mortgage rates are based, were much higher than longer-term rates - this, called a negative yield curve, isn't regarded as normal anywhere except New Zealand.
The negative shape reflected the Reserve Bank's limited ability to influence any but short term interest rates while international rates, particularly US Treasury bonds, are the biggest influence on our longer-term rates.

The norm internationally is for short-term rates to always be lower than longer-term rates - as every depositor knows, the longer your investment term, the higher your risk.

So what we used to regard as normal - and many still regard as normal - was actually highly abnormal. And it went on for such an abnormally long time - New Zealand's yield curve was negative for a sustained period between 1994 and 1998 and then was intermittently negative through to mid 2004 after which it remained consistently negative through to early 2009.

Currently, 90-day bank bills are trading at 2.95% while the five-year government bond rate is 4.24%. In July 2008, 90 day bills were 8.46% and five-year bonds were 6.18%.

ANZ Bank's floating rate now is 5.74% and its five-year fixed rate is 7.7%. In July 2008 its floating rate was 11% while its five-year fixed rate was 9.2%.

"With an inverted yield curve, it made absolute sense (to fix)," says Stephen Toplis, head of market economics at Bank of New Zealand. "Not only was the yield curve inverted, but people expected rates to go up."

Fixing was a no-brainer, as Darren Gibbs at Deusche Bank says: "not just because you were paying for certainty, but because they were cheap."

But, in a rational world, certainty normally does come at a cost.

So, are we going to return to "normal" any time soon?

Gibbs says no, barring the global economy turning to complete custard, pushing down our longer-term interest rates, and the Reserve Bank failing to respond by cutting its official cash rate (OCR).

While Toplis expects short-term interest rates will rise more and faster than Gibbs does, he isn't forecasting a negative yield curve either, barring catastrophe.

"The decision (to fix or not) becomes a lot more complex when you have an upwardly shaped yield curve and it becomes more complex again when there's no certainty about where interest rates are going," Toplis says.

"It's very much an environment where individuals have to make decisions based on their cash flow and their tolerance for risk."

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