Summary.   Last month I wrote about how the surprisingly high September year inflation number of 7.2% meant extra upward pressure on interest rates and a pushing out in time of when the housing cycle would likely reach its bottom. This month the theme is the same though with a few more reasons to add into the mix.

Rates a little bit higher

Tony Alexander

Friday 2 December ‘22

On November 23 the Reserve Bank met expectations by taking its official cash rate up 0.75% to sit at 4.25%. They also lifted their projection for where the rate will peak from 4.1% to 5.5% which was slightly higher than market expectations which immediately ahead of the rate review were at 5.1%.

The key message from the monetary policy review however came not from the interest rate numbers but the words used by the central bank. They warned about the need to put the economy into recession in order to get inflation under control and how a range of factors were combining to create greater than expected inflation risks.

Specifically, they noted that in spite of falling house prices, rising interest rates, and high consumer pessimism, householders continue to spend. They also noted the stronger than expected rebound in foreign visitor numbers, and the better than expected net migration inflows.

These things add up to the downward track for inflation looking less imminent and perhaps slower when it does appear than had been expected.

On this basis, should we have deep concerns that interest rates will be pushed a lot higher for home buyers?

That certainly is the message which people have picked up and the early results from my monthly survey of real estate agents shows there is a definite market impact underway. The net proportions of agents reporting that they are seeing more people attending auctions has stepped right back into negative territory. The same goes for attendance at open homes.

More agents now say that they are seeing prices falling in their location, and the country has moved to even more of a buyer’s market than it was already. Both first home buyers and investors have stepped back further from making a purchase.

However, this is where things get interesting. There is new housing market weakness because of the warnings from the Reserve Bank. There will definitely be some sizeable rises in floating mortgage rates because the cost to banks of borrowing money at a floating rat to lend floating is closely aligned with the official cash rate which has another 1.25% to go up.

But with fixed interest rates things are different. Bank fixed rate borrowing costs reflect market expectations for where the official cash rate will go – not where it is at right now. Those expectations were for a 5.1% peak before the Reserve Bank’s November 24 announcements. But just after the mid-October inflation data were released those expectations were for a 5.5% peak and it is when the markets were expecting that peak that banks last raised their fixed mortgage interest rates.

In other words, fixed mortgage rates almost fully reflect expectations of a 5.5% official cash rate.

They also reflect expectations that the rate will go down over 2024 and potentially from late in 2023 if the Reserve Bank is true to form and ends up tightening monetary policy by too much.

The chances are that with bank fixed rate lending margins still appreciably below average that we will see some further fixed rate rises. But their magnitude is unlikely to be great, especially compared with where floating rates are headed. At some stage buyers will realise that upside interest rates risk is limited, and they will form a view of their worst case scenario.

When that happens, the buyers are likely to step forward again (assuming they qualify for a mortgage). Therefore, I remain of the view that we are in the endgame for this period of falling house prices and first home buyers may be advised to take advantage of a market in which there is very little competition from investors and where vendors are becoming more and more willing to meet market pricing and get on with their lives. Come Autumn next year when the cash rate has reached its likely 5.5% peak, the talk about interest rates is likely to be turning towards eventual declines rather than extra rises, and that will bring forward some new buyers.

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