Is one or three years a better bet?

There’s debate over whether borrowers are better to fix their mortgages for a longer term now, or take advantage of the cheap one-year rates on offer.

Friday, February 7th 2014, 1:50PM

by Susan Edmunds

BNZ chief economist Tony Alexander said the current expectation that the OCR would peak at 4.5% just after the middle of next year could be misguided. That level is still just slightly over what is considered neutral. “History tells us that rates can spend a considerable period of time above normal.”

He said fixing for two years now would mean the rate would mature at the beginning of 2016. Three years might be a better bet, he said. “The risk is that at that time there will be scary stories of cash rates rising much higher than the 4.5% we have pencilled in then.”

He said that could cause some inexperienced borrowers to panic and lock in much higher long-term rates then.

Alexander said it was hard to imagine the Reserve Bank easing the cash rate until the Christchurch rebuild waned.

The rebuild was not expected to peak until 2017.

Borrowers would need interest rate protection through 2016, 2017 and 2018, he said, because the interest rate cycle this time would not look the same as a normal one.

“The Reserve Bank will raise interest rates to try and buy time for growth in labour and capital inputs plus productivity gains to catch up with growth in aggregate demand in the economy. Buying time means spinning expected growth out over a longer period of time. In the case especially of the necessary rebuild of Christchurch, the necessary building of previously not-built houses in Auckland, the beefing up of capacity in its many forms in the dairy sector, and improving the country’s infrastructure plus earthquake ratings for buildings, this means flattening the growth over more years rather than causing the construction to never happen.”

But Gareth Kiernan, of Infometrics, said while the Christchurch rebuild was likely to take a long while, it was hard to see the rest of the economy being stretched for the same length of time.

“It’s a risk but most forecasts pick the rate peaking in 2015.”

He said if borrowers valued certainty, a three-year rate would be a way to get past the 2016 rate peaks. “Whether it’s the best bet, I’m not entirely sure.”

Kiernan said rates would have to rise significantly over the next year to make it a bad move to fix for a cheap one-year term now. “Even with a faster pace of tightening over the next year it still make sense to fix for one year.”

He said if someone took a one-year rate of about 5.5% now the two-year rate would need to rise to 7.15% in a year’s time to make a three-year rate more worthwhile. He said that was quite a substantial increase and was probably unlikely.

“I would be surprised if it went that much but the three-year rate might not be a bad option if you want certainty.”

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