Cuts totalling 1% forecast in first half
Mortgage interest rates are set to fall further this year as the Reserve Bank cuts the official cash rate to stimulate demand in the economy.
The wholesale cash rate, currently 4.25%, was cut three times in 2024. Leading economists are now forecasting total cuts of up to 1% in 2025, bringing the OCR down to 3.25%.
Following a period of record-low mortgage interest rates, the official cash rate started rising in October 2021, peaking at 5.5%.
ASB Wealth senior economist Chris Tennent-Brown (pictured above left) and Infometrics chief forecaster and operations director Gareth Kiernan (pictured above right) are forecasting a 0.50% cut to the OCR on Feb. 19.
“We’re picking a 50-basis-point cut at this meeting and another 50 basis points to come, which we think [will be] spread over the next few meetings,” Tennent-Brown said.
That would take the official cash rate to 3.25%, which according to ASB forecasts, will occur over the next three to four Reserve Bank meetings, or around the middle of this year.
While the Reserve Bank would consider new inflation and unemployment data, due out over the next six weeks, Kiernan said that it had already indicated that a 0.50% cut would be the starting point.
“It would be [strange] if they cut by 0.50% and didn’t follow up with at least one more 0.25% right away,” he said.
Short-term fixed rates tipped to fall further
While variable mortgage rates fell in response to the 0.50% cut in November, economists noted that market expectations on future official cash rate movements had been largely priced into fixed mortgage rates.
This meant that borrowers in a position to refix their mortgage in November didn’t see equivalent falls after the OCR cut occurred.
Kiernan said that compared to levels before the November announcement, 1-year, 18-month and 2-year fixed rates were down around 15 basis points.
He noted that there were other factors influencing financial markets over this period, including concerns over medium term inflation pressures and anticipation of policy changes following the election of Donald Trump in November.
“International trends created a bit of a floor under some of the longer-term wholesale rates, and therefore the effects of that have gone through into longer-term fixed mortgage rates,” Kiernan said.
Shorter-term rates (e.g. 5.5% fixed for 2 years) were now below the levels of three- to five-year fixed rates. This suggested that the market is further along the easing cycle and that further rate cuts would potentially need to be counterbalanced by rate rises further out, indicating a return towards more normal economic conditions.
Tennent-Brown described the movement in rates as similar to the swoosh synonymous with the Nike brand, with the sweet spots typically lying in the shorter-term, one-year and two-year fixed rates.
He noted that cuts to the five-year fixed mortgage rate occurred before rate cuts started in August 2024, ASB’s rate having reduced from a peak of 6.99% to 5.50% to 5.80%.
He also expected the five-year rate to stay relatively stable, agreeing with Kiernan’s view that shorter-term fixed rates, such as the 6-month and one-year rates, would likely fall further over this year.
“We had an inverted curve for a long time where the five-year rate was the lowest rate on offer … over the course of this year, that should return to a more normal shape,” he said.
“That’s why we expect the declines to come in the short-term rates, and the floating rates [to] stay fairly steady for the long-term rates.”
How far might short-term fixed rates fall?
Financial markets signal future interest rate cuts, and Kiernan said current market pricing suggested that similar to Infometrics’ forecast, markets currently expected the official cash rate would be between 3.25% to 4% by mid-year.
A 0.50% cut in February could see mortgage rates for terms of up to two years fall between 10 to 15-basis points, he said.
Kiernan estimates that a 3.25% cash rate would see short-term fixed mortgage rates fall to the range of 5.4% to 5.5% - similar to the two-year fixed mortgage rate available in January. If swap rates don’t push back up and long-term bond rates don’t reduce, the drop could be slightly larger, he said.
According to Tennent-Brown, the two-year fixed rate had held its own as being relatively competitive at around 5.5%. He questioned the logic of mortgage borrowers keeping their loans on higher variable rates, while they wait for mortgage rates to fall.
“It’s not a game of trying to pick the bottom, it’s a game of trying to lower the average interest rate you pay over your mortgage,” he said.
“Sitting on a floating rate has been pretty expensive, particularly when you can get straight into a rate that (at 5.5%) could well be within 20 or 30 basis points of the low.”
When will rate cuts benefit borrowers?
According to Infometrics September data, which captured the period when the one-year fixed rate dropped below the average rate paid, 19% of lending was due to roll off fixed rates by the end of 2024, with almost an equivalent portion to roll off over the quarter ending in March 2025.
In August, 48% of new mortgage lending was fixed for six months, compared to just 5% over the same period in 2023. This indicated a strong preference among mortgage borrowers to fix for shorter terms in anticipation that rates would fall, a trend that was also captured in the December mortgages.co.nz & Tony Alexander Mortgage Advisers survey.
At 2.2% for the September 2024 year, inflation is the lowest in over three years. Non-tradeable (primarily domestic) inflation remained elevated at 4.9%, the Reserve Bank noting in November that rents, Council rates and insurance were rising faster than normal.
In response to what would cause the Reserve Bank to cut the official cash rate by more or less than what is forecast, Tennant-Brown said that the Reserve Bank would want to weigh up the capacity of the economy. While headline inflation was back in the 1% to 3% target band, there were still areas it would keep an eye on, including the December GDP data showing a 1% contraction in activity over the September quarter.
“We think all of those things still support going 50 basis points in February and looking carefully at the data over the coming month,” he said.
Tennent-Brown anticipates that lower interest rates and a lower exchange rate will lead the country to the next phase of growth, benefiting households and exporters. Among the positives for the economy are the dairy industry and sheep and beef prices, while the risks lie in softening migration flows and delayed turnaround of the labour market.
“There’s a lot of moving parts that we hope just mean we get a slow grind over the year ahead and a few more good stories in the economy than what we’ve got at the moment,” he said.
