Private property issue #27 - tony alexander's predictions

Last week, Ed and I had Tony Alexander (an independent economist) on the Property Academy Podcast.

So…we took the opportunity to quiz him on where interest rates are heading.

Our podcasts with Tony begin releasing tomorrow. But here’s a sneak preview, exclusively for Private Property readers.

You've just removed your 1-year rate predictions from your newsletter – Tony's view – why?

“One of the key fundamentals in predicting interest rates is an assumption about bank margins.”

“Clearly the competition between banks is making them radically compress their 1-year interest rate margin.”

“I don’t know how to predict the margins from the banks, so I thought I would strip it out for a bit to see how things went later on.”

“A lot of the banks’ own customers are rolling into a new rate, so they don’t want to lose them.

You've previously predicted that the 1-year mortgage interest rate will be 5.75% in mid-2023. Will this now go higher because of the OCR?

“I think interest rates will fall on the low side of the 5.75%.

“I looked at my normal analysis, and thought - ‘No...this still makes sense at about 5.75%’.

“But only if I believed the margins were going to go back to the historical average for the banks.

“The evidence on the face is that margins are low, so that’s why I think rates may be on the lower side of 5.75%.”

Where will interest rates be 3–5 years?

“I do see the rates generally going down from here. But the speed of decline is not going to be rapid.”

“We’re not likely to see rates returning to the previous average of 3.1% at the start of 2020. But we’re also not going to go back to the 1990s where the average interest rate was 8.5%.”

“So, maybe just about 4%, something like that.”

Why are mortgage interest rates coming down if the OCR is going up?

“Banks fund floating rate lending with floating rate borrowing. That’s why the floating rate the banks pay is closely related to the OCR [which is a floating rate].”

“But when a bank lends for a fixed term for 3 years, they don’t fund it using a floating rate – instead they use wholesale rates.”

“So really, the interest rate reflects the average of what the market thinks the OCR might do over the next 3 years, not where it is right now.”

“And of course, the market expectation is the Reserve Bank going to be dropping the OCR late 2023 … so they will be factoring in 2 years of shortfall.”

Ballpark ... where do you think interest rates will be in 10 to 15 years time?

Ballpark ... where do you think interest rates will be in 10 to 15 years' time?

[laughs] “We know whatever I saw will probably be wrong.

“Maybe the long term is going to be 4.5%, maybe 5% long term for the next 10 years. No one has the foggiest.

“What we are aiming for is to recognise when we are going to be wrong relatively quickly.

“The lesson for all of us – over the past few decades – is shocks occur, always occur, you don’t know when it's going to come along, what it will be, how bad it's going to be, how long it’s going to last, and what the recovery will be on the other side.”

Tune in to listen to the full podcast tomorrow @ The Property Academy Podcast

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