Interest rates set to spiral further upwards

Fixed mortgage rates rose steeply after Reserve Bank governor Alan Bollard raised his official cash rate (OCR) in March and are set to rise even further on review later this month.

Tuesday, April 24th 2007, 12:00AM

by The Landlord

By Jenny Ruth

That partly reflects rising bank profit margins – on two-year mortgages, margins had shrunk down to about 50 basis points before the March OCR review but they have since risen to about 90 points.

Brendan O’Donovan, chief economist at Westpac says that in the lead up to the central bank’s late April OCR review, wholesale interest rates have risen further while bank margins stayed steady, suggesting that fixed mortgage rates are likely to head even higher.

“With the (strong) run of data, the market’s now believing the Reserve Bank that interest rates are going to high for a long time,” O’Donovan says.

That data includes stronger than expected retail sales, accelerating house price inflation, and an historically low unemployment rate of 3.7%.

Up until late last year, the wholesale interest rates market had been expecting the OCR to start falling this year, despite Bollard’s protestations to the contrary.

Given the level of house price inflation in recent years, for property investors, this marked hike in interest rates means that rental yields have been driven down below 3%.

“When you’ve got this magnitude of debt servicing costs, it really does start to change the value proposition for investors,” O’Donovan says.

While floating mortgage rates have also risen from 9.55% before the March OCR review to 9.8% in late April, the difference between them and floating rates has narrowed substantially – in November last year five-year fixed rates were 180 basis points lower but were only 100 points lower by late April.

“There’s no longer anywhere for borrowers to hide,” O’Donovan says. “Previously, people were tumbling down the curve (from shorter to longer fixed periods). Now everyone’s starting to hurt from the high rates.”

Nevertheless, it still takes some time before all mortgage holders feel this pain. With the average mortgage term currently at 1.8 years, about 41% of the $132 billion in mortgages currently in force are due to roll over onto new rates this year.

“Even if interest rates held at current level, as existing fixed rates roll onto those higher rates, that will mean $760 million per annum in additional debt servicing costs on the existing stock of debt over the next two years,” O’Donovan says.

And he thinks interest rates, and therefore debt servicing costs, are heading higher – he thinks by about a further 50 basis points by June.

Craig Ebert, an economist at Bank of New Zealand, doesn’t think the recent rise in mortgage rates will have as much impact on the housing market as some people think.

“There’s just so much momentum in the housing market.”

With two-year fixed mortgages the most popular in the market, by the time it comes to needing to re-fix, people’s incomes will have risen sufficiently to accommodate the increases in the pipeline, he says.

“The Reserve Bank’s got a lot to row against – 25 points, or even 50 points (increase in the OCR) isn’t going to stop this thing in its tracks,” Ebert says.

“We think a lot of people are going to be surprised by how little effect these mortgage rate rises are going to have.”

Nick Tuffley, chief economist at ASB Bank, expects Bollard to “be talking fire and brimstone” to keep the wholesale interest rates anticipating further rate hikes, regardless of whether or not he decides to raise the OCR.

“You can bet your boots that Bollard’s still going to be making noises that further rate hikes can’t be ruled out.”

« Property investors refocus on cash flow

Free Investment Property Showcase Events: Auckland, Wellington and Christchurch »

Special Offers