Why interest rates change

Interest rates are always subject to change, which means they can go up or down. To answer some frequently asked questions about why mortgage rates can increase, we sat down with our Chief Economist Jarrod Kerr in December 2022. This is an insight into rate changes.

Why have mortgage rates increased?

It can be daunting to see mortgage rates increase, but interest rates always move with the economic cycle. As we can see in the current cycle, the movement in interest rates can be quite volatile. When economic growth is slowing, interest rates are slashed to stimulate growth. We saw a historic low in interest rates during the COVID-19 pandemic.

When the economy is heating up, interest rates are lifted to cool the economy down and tame the inflation beast. Interest rates have been hiked aggressively by the Reserve Bank of New Zealand (RBNZ) which, in turn, causes banks to hike interest rates, in response to rapid price increases.

Will mortgage rates keep increasing?

Many people have been asking this question and the answer is that the RBNZ will continue lifting interest rates until they have seen a clear turn in inflation. I know the volatility in interest rates in recent years has been dramatic, but we expect interest rates to peak in 2023 as the economy cools and inflation eases.

What has happened historically with mortgage interest rates?

Mortgage rates can fluctuate a lot. When the Global Financial Crisis hit in 2008, mortgage rates peaked at over 10%. In the aftermath of the COVID pandemic, mortgage rates hit historic lows at just over 2% in early 2021. When the economy is running hot, and generating inflation, mortgage rates rise. And when the economy is cooling, mortgage rates fall.

What is the OCR?

We've been hearing this term a lot. The Official Cash Rate (OCR) is the main tool the Reserve Bank of New Zealand uses to influence all interest rates in the economy. When the OCR is hiked higher, all interest rates follow, and mortgage rates rise. The OCR is lifted by the RBNZ to cool the economy down and tame inflation. The OCR, and mortgage rates, have also been lifted to slow the housing market down. The OCR is cut, lowering mortgage rates, when the economy needs stimulating.

What is the relationship between the OCR and mortgage rates?

All wholesale and retail interest rates in the economy are linked to the OCR. When we talk about 'all interest rates', they include wholesale bank bills, government bond and swap rates, retail term deposit rates, business lending rates, and mortgage rates. When the OCR is hiked higher, all these interest rates follow, and mortgage rates rise.

What is CPI?

The Consumer Price Index (CPI) is the best measure of inflation for Kiwi households. Interest rates are used to influence inflation (CPI). High inflation means higher interest rates. The CPI measures the changes in prices of goods and services in New Zealand. Inflation, the rise in prices, is said to be stable at around 2% per annum. The RBNZ is mandated to keep inflation between 1-and-3% year on year, and they target the 2% midpoint. In 2022 inflation hit 7.3%, but we believe this peaked in the year to June 2022 and should now ease off so that it falls back to within the RBNZ's target band.

What is your forecast for inflation and mortgage rates over the next two years?

As previously mentioned, we believe inflation peaked at 7.3% in the year to June 2022. We expect to see inflation easing from here. Inflation should fall back to within the RBNZ’s target band of 1-to-3% late in 2023. Mortgage rates are likely to peak at higher levels in 2023. And mortgage rates are likely to hold at higher levels for a while. By the end of 2023, we expect mortgage rates to start falling again.

How have increased mortgage rates impacted house prices?

The rise in the OCR, and therefore mortgage rates, is designed to slow the housing market down. Rising mortgage rates makes the cost of servicing a mortgage more expensive and reduces demand. The recent rise in mortgage rates, and tougher lending rules under the CCCFA regulations, is having a significant impact on the housing market. House prices are currently falling, and our forecast represents a 21% drop from peak to trough, taking prices back to levels seen in late 2020.

What do rising rates mean for savers and term deposits?

We must remember, for every borrower there is a saver. And savings rates are increasing as well. Savers suffered during the pandemic as interest rates were slashed. Now savers are receiving term deposit rates well above 5% per annum, which means those who are dependent on income from their savings, for example retirees, have more in their pockets. So, while some households pay higher rates on their home loans, other households receive more in interest income.

Need some help?

If you’ve made a budget and you see a big shortfall between money coming in and money going out, then don’t be scared to ask for help. Give us a call, or, if you want budgeting advice, visit MoneyTalks, which offers free budgeting advice and is run by the national charity FinCap and is supported by the Ministry of Social Development. The Citizens Advice Bureau can also help you find local budgeting services that can help you sort out your finances.

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