Tony Alexander Update December 2022
Mortgage rates peaking
Last month I noted that there was a 70% chance we were at the cyclical peak for fixed interest rates. But the 30% probability has come into play in the form of the Reserve Bank’s tightening of monetary policy on November 23. The 0.75% increase in the official cash rate was marginally above market expectations as was their pick for the peak in the cash rate in April next year of 5.5%.
In response to the extra tightening of monetary policy and words from the Reserve Bank warning about the need for a recession and high interest rates we have seen some small increases in bank wholesale funding costs. By themselves these increases don’t necessarily justify the 0.5% or so increases in fixed mortgage interest rates which are now under way.
But for much of this year bank margins on fixed rate lending have been well below average and it appears that banks have, logically from their point of view, taken advantage of the warnings from the Reserve Bank to restore margins back towards the average levels for the past two years.
Will interest rates for borrowers still go higher? Probably not, and this time around I would give a 90% chance to us now being at the peak in the fixed mortgage interest rate cycle. Why?
Offshore we are seeing evidence of inflation falling, oil prices have declined, shipping costs are going down, annual inflation rates have fallen in the United States and Europe, and central banks overseas are indicating they intend slowing down the pace of increase in their official interest rates.
Here in New Zealand, we have just seen the ANZ monthly Business Outlook survey reveal a new steep decline in business sentiment along with negative intentions of hiring more people and boosting capital expenditure. The important thing about this survey is that practically all the results came in before November 23. There is a risk that the Reserve Bank is now over-tightening monetary policy.
The financial markets in fact may be coming around to that view in light of the collapse in business sentiment along with a decline in building consent numbers now starting to appear, a fresh fall in consumer confidence, and the results of my latest survey of real estate agents all around the country.
The survey shows that as a result of the Reserve Bank’s extra monetary policy tightening both first home buyers and investors have stepped even further back from the market. Agents are now newly seeing fewer people show up at auctions and open homes and more consider prices to be falling in their location.
I think there is an element of shock and awe in these results and in particular expect first home buyers to come back into the market as we move through summer. House prices have fallen over 12% from their peaks, incomes have risen almost 9% in the past year, banks are slowly easing their lending criteria, the labour market remains very strong, listings are well ahead of levels a year earlier, and first home buyers face very little competition from investors at auctions.
I'm still of the view that the housing market generally will bottom out in the autumn to winter period next year and a key factor likely to bring buyers generally back into the market is a change in view on interest rates. As soon as people can see the worst case scenario for mortgage rates, they will focus their attention on when those rates start falling.
The chances are good that the medium to long term fixed interest rates will be falling before the middle of next year and the popular one and two year rates are likely to head slightly lower before the end of 2023.
Another thing to keep an eye on is where the political opinion polls are going. As the probability assigned to a change in government at next year's general election goes up, we can expect more investors to re-enter the market in anticipation of interest expense deductibility returning.
Overall, the residential real estate market remains in a considerable state of flux. In particular, we are in a period now when the effects of rising interest rates from the middle of 2021 are starting to show up. Inflation forecasts will fairly soon start falling. The state of confusion is likely to lead to some small downs and ups in interest rates and borrowers should keep an eye out for the specials which banks will be running. After all, it pays to remember that banks are in the business of lending money and with their margins on fixed rate lending now having been restored we should not be surprised if any falls in wholesale interest rates partly attributable to an improving inflation outlook offshore lead to some early rate discounting here in New Zealand.
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By Tony Alexander