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Property Market Update - 17th Nov 2017

Property Market Update

By Tony Alexander.

Every six weeks or so the Reserve Bank reviews the level of its official cash rate and makes the decision whether to move it up or down or to leave it unchanged. They move the rate up when they think that the outlook has changed so that inflation could turn out to be higher than they were thinking six weeks earlier. They move it down when they see things suggesting that unless the rate gets reduced inflation could end up settling too close to the low end of the 1% - 3% target band. If nothing changes, or changes up are matched by changes down, then they do nothing.

That is what they have been seeing and doing since they took the cash rate to 1.75% in November last year. On November 9 they noted that there is perhaps some new upward pressure on inflation coming from the recent decline in the NZ dollar below US 70 cents, the extra spending planned by the new government, the planned increases in the minimum wage, and a recent hike in global oil and therefore local petrol prices.

But they also noted that they see some downward pressure coming from the slowing housing market. This slight downward pressure was outweighed by things pointing upward so they lifted their inflation forecasts slightly. But the key thing to note is this. Substantial uncertainty surrounds forecasts of the future and one key trick which economists have to learn quickly is that you don’t want to be changing your forecasts or in this case your setting of the cash rate just because of changes in a six week period which could easily reverse.

You need to be sure that the trend has changed and that coming up the balance of changes will again point in the direction of higher inflation. Our opinion is that the Reserve Bank will see such a trend in inflationary pressures emerging and they will make their
next rate change a rise rather than a fall.

The Reserve Bank agree, but they don’t think they will need to start raising their cash rate until the end of 2019. That means average mortgage rates are not likely to start rising in any trend way until about two years from now. However we are of the opinion that they will need to move sooner than that and think the first rate rise will come sometime in the second half of next year – one year earlier than the Reserve Bank are predicting.

For borrowers the first key point to note is that for perhaps the coming year the chances are very low that mortgage rates will rise all that much if at all. The second point to note however is that most forecasts of interest rates around the world have been wrong for ten years now and it would be unwise to blindly base one’s decisions about fixing the rate for one’s mortgage solely upon forecasts. The uncertainty itself has to be explicitly recognised.

That is why we think that for most borrowers the optimal thing to do in order to allow for this uncertainty is to fix one’s mortgage over a range of terms. One option might be to fix 30% for one year, 30% for two years, 30% for three years, and leave the rest floating in case spare cash comes along and one wants to make a partial early repayment.

What about fixing longer? Risk averse people tend to do this but it comes at a cost. For instance, a common three year fixed housing rate is currently 5.09%. The four year rate is 5.89%. This means that in order to get certainty about one’s interest rate cost for one more
year an extra 0.8% premium has to be paid for the next three years. Personally I feel that is a tad expensive – especially so if one chooses to fix for five years at 6.09%.

But it all comes down to what sort of risk a borrower is willing to take.

For investors of course this environment of ongoing low term deposit rates is all bad news. It seems reasonable to expect that now the uncertainty of the general election is out of the way savers will once again start looking for higher yielding investments. Some may opt for shares, some managed funds and some maybe will look again at property now that some under-capitalised property investors are looking to sell.

Will this investor demand driven by ongoing low interest rates cause a new generalised rise in house prices? No. For the next five years the chances are that average prices won’t move all that much. But they will oscillate and there will be bargains not just for investors, but especially for the massive number of first home buyers wanting and needing to buy.

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