Who should you listen to?

Thursday, September 3rd 2009, 1:04PM

Who do you believe about interest rates? The Reserve Bank or the financial markets?

The Reserve Bank governor Alan Bollard continues to reiterate his view that the official cash rate will stay at current levels until the end of next year, however the financial markets are pricing in increases for earlier in the year.

This stand-off is a situation I have commented on earlier. When the markets get to a turning point, like they are now, there is a tendency to predict that things will move in the opposite direction. Staying put never seems popular.

Bollard’s comment, which I agree with, is this: “The financial markets either want things to go down or they want things to go up, they just don’t seem to do stability very well, but they’re not necessarily right.”

He went onto say: “The market’s always got its own view and often it’s wrong.”

“We’ll come out with our views next week and as usual we will be absolutely clear cut about (our view on rates).”

Trying to understand what drives rates is pretty hard for mere mortals too. This has been shown at the unofficial Parliamentary enquiry into interest rates which is going on this week.

It seems not many submitters are sticking to the subject and a number of commentators are using it as a soap box for their economic views.

A graph we produced seems to suggest there is a prima facie case that banks are increasing their margins on floating rates. But are they ripping us off?

The question was put to Sam Knowles, the head of Kiwibank and no doubt the nemesis of the Australian banks. He was asked at the enquiry if the banks were “rorting” the system.

Surprisingly, he said no.

The whole enquiry has become a damp squib, made wetter because the four big banks turned down their invitations to attend, likewise the Reserve Bank is absent.

However, there is some information out this week which is useful to borrowers. It is the ASB’s Home Loan report.

The report discusses the pros and cons of various terms. A key point to remember is that when deciding what term to select for your home loan, you should be thinking about the cost of the loan over the long-term.

If, like most people at the moment, you are using short-term rates and rolling over, you can either choose to fix for longer terms, thus tying in a rate which is on the low side historically, or you can continue to use shorter-term rates and hope that the average cost over the long term is better than what you could lock in for say three years or more now.

The report gives a good example of five-year rates. Currently five-year fixed rates are 8.30%, while one-year rates sit around 5.50%. Clearly today the deal is a no-brainer. But one-year rates will increase and be higher when you come to refix next year. But will they increase by big enough margins to make the short-term option look unattractive?

The bank has done forecasts for the next 60 months and suggests even with the increases likely to come through on one-year rates, they still look like they will deliver a lower average cost over the five-year period.

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