Why is it so hard to predict interest rates?

There is increasing speculation in the media that interest rates will start to fall in the not-too-distant future. To separate the fact from fiction it is helpful to have some understanding of factors that influence mortgage rates in New Zealand.

1.       Official Cash Rate (OCR): 

The OCR, set by the Reserve Bank of New Zealand, is the benchmark interest rate in New Zealand. Changes in this will directly influence floating rates and also shorter-term fixed rates.

2.       Global Economic Conditions:

 Economic conditions globally (especially the United States) impact mortgage rates in New Zealand. Factors such as changes in international interest rates, inflation rates, and economic stability will influence investor confidence and the cost of borrowing for banks which in turn affects mortgage rates.

3.       Domestic Economic Conditions:

The state of the New Zealand economy, including factors like GDP growth, employment rates and inflation influence mortgage rates. Strong economic performance will lead to higher mortgage rates due to increased demand for loans, while economic slowdowns will prompt lower rates to stimulate demand.

4.       Cost of Funds:

 Banks acquire funds to lend through various channels with approximately 65% borrowed from within New Zealand and the rest sourced off shore. Changes in the cost of these funds will affect the rates banks offer. If the cost of funds goes up so to will mortgage rates and vice versa.

5.       Competition among Lenders:

 Competition among banks and other lenders will impact mortgage rates. When competition is high, lenders will lower their rates to attract borrowers. Conversely, when competition is low rates tend to be higher for longer.

6.       Regulatory Changes:

 Regulatory changes, such as new lending restrictions or capital requirements imposed by the Government or Reserve Bank can cost banks a lot of money to implement. We have seen a lot of these over the last few years. These costs will be pasted on in terms of higher mortgage rates.

7.       Market Expectations:

Expectations about future economic conditions, interest rate movement, and the housing market trends influence mortgage interest rates. Lenders may adjust rates based on their predictions of future market conditions.

8.       Term Length:

 The length of fixed- rate term can also impact mortgage rates. Generally, but not always longer-term fixed rates mortgages have higher interest rates compared to shorter term ones, reflecting the increased risk for lenders associated with locking in rates for a longer period.

These factors do tend to compete against each other to differing degrees at different times and help to determine not only the timing but also the extent of increases or falls. This is why interest rate predictions are more art than science!