Private Property Issue #40 - Higher Interest Rates...

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Phew – it’s been a big week in the Kiwi financial market.

Here’s what happened:

#1 – OCR jumps from 3.5% to 4.25%

The Reserve Bank announced its 9th OCR hike in a row … and it was a big one. The Reserve Bank’s interest rate went up 0.75%.

They did this because the prices of the things you and I buy are going up too quickly (inflation).

Prices are going up by 7.2% a year, and the Reserve Bank’s target is 1-3%.

Why’s this happening? We’re all spending money while businesses are struggling to get workers.

It’s the old supply and demand problem. Households want to buy stuff, but businesses are struggling to supply it. So prices go up.

#2 – The bank increased its OCR forecast.

Every 3 months, the bank puts out the “OCR track.”

This is their ballpark forecast for how high their interest rate (the OCR) will go.

They lifted their anticipated peak from 4.1% to 5.5%. That means the OCR could go up another 1.25% by mid-next year.

Though this will come down once inflation starts to track downward. The bank currently says that will happen by late 2024. But I expect it will happen much earlier.

What’s the impact on mortgage interest rates?

The most recent OCR move won’t impact interest rates that much. That sounds controversial, but there are two reasons for this:

1) The hike is mostly priced in

Banks (and the places they borrow money from) set their interest rates based on what they think will happen in future.

So, if banks (and financial markets) think that the OCR will go up in future, they set today’s interest rates on that basis.

That’s why last week’s OCR increase had little impact on mortgage interest rates.

We were all already expecting an 0.75% increase. So, it was already priced in.

You might think … “then why did ANZ and Westpac just lift all their interest rates by about 0.5%?”

Because interest rates adjust based on new information.

Before the announcement, the financial markets thought the OCR would peak at about 5.1%.

But with the Reserve Bank saying it’ll go up to 5.5% … that’s the new information.

This week’s OCR rise wasn’t the critical info … so rather than ‘pricing in’ a 5.1% OCR, markets will price in 5.5%. A 0.4% increase.

And that’s why we’re not going to see interest rates get up to 9-10%.

2) Banks are finding cheaper ways to lend money to you

About 70% of the bank's mortgage money comes from term deposits and on-call accounts.

These are cheaper sources of money than borrowing it from overseas.

See in the below graph how the banks are getting more of the cheapest sources of funding?

What does that mean? Banks have raised interest rates by less than what the OCR increases would imply.

Here’s what Reserve Bank assistant governor Karen Silk had to say:

“...while we have seen an increase in wholesale rates, that hasn’t flown through on a 1 for 1 basis through to retail [mortgage] rates … that’s the important fact.”

Put simply, the Reserve Bank needs to raise the OCR by a lot … to get the retail mortgage rates to shift a little.

All because the banks are finding cheaper ways to lend.

And again, that’s why we will see some increase in interest rates … but we’re not going to see humungous increases over the next 6 months.

What are my predictions … all these changes considered?

With all that, our current interest rate predictions are:

• 6.5% in December 2022

• 7% from December 2023

• 5.5% in December 2024

After this, we forecast they’ll settle into 4.5% as the long-term average.

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