Last November the Reserve Bank’s Adrian Orr suggested mortgage rates needed to stay where they were “for a long time to come”. Economists wonder if lower mortgage rates are closer than some think.

Generally, higher inflation leads to higher interest rates.

The good news is that New Zealand’s rate of inflation looks set to fall in 2024. However, any drop is unlikely to be quick or spectacular given high property rental prices.

The UN’s World Economic Situation and Prospects report published earlier this month forecasts New Zealand will end 2024 with inflation at 3.4%, then drop to 2.6% in 2025.  The Treasury is a touch more optimistic, forecasting inflation back within the Reserve Bank’s target 1-3% range by the end of this year.

Room to move

Swap rates – the cost to banks of borrowing money at a fixed rate – have fallen considerably over the last few months, leading some commentators to suggest that banks now have a sufficient margin to lower interest rates.

Squirrel chief executive David Cunningham suggests rates should already have dropped, given the sharp fall in wholesale rates before Christmas. “I would be surprised if we don’t see most fixed interest rates down between 0.5% and 1% by March. Bank margins are very wide at the moment,” he said.

Not so fast

The potential for longer-term mortgage rates to move lower looks likely if the decline in wholesale rates is maintained.

However, the question is whether markets have got ahead of themselves. BNZ chief economist Mike Jones thinks they have. “I think if December’s big falls in wholesale rates are sustained there would be scope for mortgage rates to fall. But markets have probably got a bit ahead of themselves in this regard”, he said. “There’s a tonne of Reserve Bank easing priced in for later this year and it seems unlikely the bank will endorse this given their ongoing inflation concerns. The other thing to bear in mind is that term deposit rates – a key component of bank funding costs – are yet to fall. So, the risks to fixed mortgage rates are lower but I think we’ll have to wait until later in the year for a sustained downtrend.”

Record migration a spanner in the inflation works?

Inflation is a tricky beast, reflecting tradeable inflation – think imported goods – and non-tradeable (domestic) cost prices, such as housing. The former inflation marker is slowing. However, non-tradeable cost prices have risen, with last year’s figures showing the fastest domestic-focused inflation rate on record.

Record migration plays a role, too. On the one hand, extra bodies take heat out of the labour market, but on the other, more people means more spending, which by nature is inflationary.

Treasury said there was “considerable uncertainty” about how the population would grow in the year ahead and if the major boost in immigrants seen in 2023, which was tens of thousands of people higher than every year for the past two decades, would continue.

However, with non-tradeable cost prices yet to abate, the Reserve Bank is unlikely to lay down its sword and move to cut rates before they believe inflation is well and truly back under control.

Let’s see.

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