Rate cuts predicted, but beware

Thursday, June 5th 2008, 4:42PM

News today that the Reserve Bank has brought forward forecasts for cuts to the official cash rate is welcome.

A look at the market reaction to the announcement indicates we are likely to see lenders drop some rates, particularly those at the shorter end of the curve, quite aggressively. For instance don't be surprised to see cuts of 40 basis points or more for one-year rates.

However, things aren't 100% rosy. A reading of the bank's monetary policy statement shows that the effective mortgage rate borrowers are paying is at historically high levels and won't start coming down immediately.

The effective mortgage rate is the average rate being paid on outstanding mortgage debt. Mortgage borrowers are rolling over their existing mortgage debt onto higher interest rates than they were paying previously, thus pushing up the effective rate.

The RBNZ says the effective mortgage rate has increased by about 170 basis points from its lows in late 2003, and has reached its highest level since October 1998. It says around 30% of the existing mortgage debt on fixed rates will re-price over the next 12 months.

On the basis of currently available mortgage rates, many of those borrowers will face interest rates that are more than 100 basis points higher than they are currently paying.

Another issue to be aware of is that rate changes can move unexpectedly in directions you can't predict. We have seen this in the past couple of weeks. Firstly banks first dropped quite aggressively their short-term fixed rates and left longer-term ones unchanged, then a matter of days later reversed the trend putting rates of terms of three years or more down and shorter-term rates up.

The third point is that the Reserve Bank put a number of conditions on cuts. These conditions were on things beyond its control (commodity prices, exchange rates etc). If they don't pan out then the homeloan rates we see in the next few days may not have a lot of longevity.

The message here is that there is still a lot of volatility in financial markets and data releases with unexpected outcomes can make lenders quickly change rates.

« It's raining rate relief!

Looking at the bigger picture »

Special Offers