Why fixed mortgage rates are headed up already after Reserve Bank cuts – Inside Economics

Banks’ answer is that their rates had already “priced in” the OCR reductions.

But they need to produce some simple charts to prove that!

I know you can ask the right questions, but not sure if you will get any meaningful answers that we borrowers can understand.

Kind regards

Graeme Finch

A: Great question, Graeme, one that has a few layers to it.

It was certainly frustrating for many Kiwis to see fixed rates unmoved after the latest – and possibly last (in this cycle) Official Cash Rate (OCR) cut.

And, as of yesterday, we’ve seen Westpac lift its two to five-year fixed rates, albeit with a small drop in its six-month rate.

Before I get into it all, I want to make the point that I’m not here to defend the banks and, in particular, I’m not here to defend their margins and profits.

I’ll leave that to their chief executives.

But the explanations the banks give for the way retail mortgage rates move relative to wholesale markets are reasonable (in a context where we assume they maintain current margins and profits).

Retail rates do follow wholesale pricing, and that means the speculative activity on financial markets plays a big part in things.

Financial markets are always looking forward, trying to stay ahead of the curve. This means we do see rates get priced in based on expectations of what the Reserve Bank of New Zealand (RBNZ) is going to do.

It also means markets have to correct quickly when the RBNZ’s action doesn’t match the speculation.

In October, the rate cut was so widely anticipated by markets that it was largely priced in.

We did see some fixed rates move before the OCR decision.

The same thing might have happened in November, but the RBNZ’s forecasts didn’t match the market.

In fact, the RBNZ forecasts suggested a much lower chance of another rate cut in February than markets had anticipated.

This and commentary from the bank meant the markets had to move to correct their positions quickly.

Westpac’s take

Westpac chief economist Kelly Eckhold put out a research note on this very topic last week.

Eckhold noted that in the days following November’s Monetary Policy Statement (MPS), benchmark wholesale interest rate swap rates increased by 15-30 basis points, with longer maturity rates rising by more than shorter maturities.

In the past week or so, interest rates have moved off those highs as the markets have consolidated.

Nevertheless, the direction of travel for wholesale rates since the OCR call has been up, not down.

Westpac chief economist Kelly Eckhold.

Here’s how Eckhold explains it:

“The big driver of the increase in interest rates has been shifting expectations of when markets see a rise in the OCR above 2.25%. Prior to the MPS, markets saw chances of a further cut in the OCR to 2% by the middle of 2026 and then a very gradual rising trend after that.”

“This would have meant the OCR would remain below 2.5% until mid-2027. After the MPS, markets have significantly reduced the perceived chance of a further OCR cut (from around a 60% chance to perhaps a 20% chance now) and have brought forward their view of when the OCR will rise above 2.5%.

“Market pricing now implies some risk of an OCR hike from 2.25% in May 2026 and a full hike by December 2026.”

So essentially the market was wrong-footed by the RBNZ … or the RBNZ wrong-footed the market.

Deliberate move?

There has been some debate about whether this was an intended consequence or unintended on the part of the RBNZ.

The Herald’s Wellington business editor Jenée Tibshraeny canvassed this in the aftermath. She talked to various experts and landed on two scenarios:

1) The Reserve Bank bungled its comms and may need to do more to support the economy

2) Banks are well placed to keep interest rates suppressed for the time being

Tibshraeny also followed up with the (then) acting Reserve Bank Governor Christian Hawkesby.

Hawkesby told the Herald, “I think we had an awareness of what the market reaction might be to our decision …

“We always have our markets team brief us on the likely reactions to different decisions we make. So it sort of fell in the ballpark of what we expected.”

If the RBNZ did expect the market reaction, it suggests it must have seen some upside to mortgage rates not falling any further.

The simplest explanation for that is they are worried about inflation.

It is now the RBNZ’s sole mandate to keep inflation between 1% and 3%.

It is currently sitting at 3%, although most economists expect it to track down in the next few months.

Effectively, calling time on rate cuts also has the advantage of sending a clear message to borrowers, who will now be more likely to lock in for longer periods on the assumption that rates are at a cyclical low.

One of the reasons the recovery has taken longer to take hold in New Zealand than many expected is that we’ve had record numbers of mortgage holders on higher floating rates.

It seems people have been delaying locking in longer-term fixed rates while they wait for the low point.

That has actually diminished the pass-through of OCR cuts to consumers and the wider economy.

Therefore, a big wave of people locking in now might be good for the recovery.

One side effect of that, though, is that if banks do suddenly face outsized demand for two- to five-year terms, they may have to source more funding from offshore debt markets.

Given what has been happening with US treasuries, it’s likely this will also put upward pressure on local pricing.

The margins

The RBNZ publishes a record of the average net margin local banks have been charging above the OCR.

Since 1996, the margin has ranged between 1.81% and 2.85%.

It was at its lowest in 2020 and 2021 as the OCR was slashed to record lows. The highest era for margins seems to be around 1996 and 1997, which (if I stretch my memory) might have had something to do with the Asian financial crisis.

Anyway, they are currently sitting at 2.31%. They’ve been there or thereabouts for the past three years.

So I don’t think there has been a specific margin grab by the banks based on these last two OCR cuts.

Again, I want to stress that this is just an explanation, not an excuse.

Banks still have a choice when it comes to passing on rate cuts.

It’s just that they would have to cut into their margins to do it, and that would mean lower profits.

From a business point of view, they want to maximise returns for their shareholders.

I don’t think we’re going to see much movement on that front until they face more competition – something I hope the Government can develop in the years ahead.

Pension problem

Q: Hi Liam,

With regard to the affordability of the pension into the future.

I have been thinking of a possible solution to the problem.

I struggle to get my head around people still working, plus also receiving the pension at 65.

My thoughts, and one I would be totally happy with, is to remove the pension from people who continue to work and make say $200,000 pa or more (income-based not means-tested).

Surely anybody who complains about it is just plain greedy and does not have the country’s wellbeing at heart.

I would be more than happy to accept this if it meant my children and grandchildren will grow up in a better New Zealand.

This would be so easy to apply as your yearly IRD return would become the Government’s trigger.

I would love to hear your thoughts.

Regards

Dave Smith

A: I hear you Dave. It doesn’t make any sense for working people earning a large salary to receive Government support.

People have the right to retire at 65, and I think there needs to be leeway for those who need or want to keep working to do so without being penalised.

Many will argue they’ve paid a lifetime of tax towards superannuation, and it is a right.

In fact, the way the demographics are trending in New Zealand, we’re going to need people to keep working longer, so we don’t want to create a disincentive.

But as you suggest, a generous cap at something like $200,000 a year seems more than fair.

People on high salaries typically have more choices available to them with regard to their financial future. They could still take the pension when they decide to stop work or reduce their hours.

This also seems fairer than means-testing based on assets, given that many older people are left with high-value homes but very low cashflow.

So I think your idea, or a version of it, should be in the mix for those looking at reform.

I suspect it wouldn’t impact a large number of people and therefore wouldn’t alleviate the funding burden hugely for the Government, though.

I am of the belief the NZ Super age needs to start rising sooner rather than later.

In a recent column, Matthew Hooton suggested: “There’s no reason the eligibility age couldn’t start moving up by three months a year from April 2026, to align with the KiwiSaver changes already announced in this year’s Budget.”

That won’t happen. But I like the increments of three months a year.

The slower we do it, the fairer it is going to be for those planning their retirement, but if we want to do it gradually then we need to get going.

National campaigned at the last election to gradually increase the eligibility age from 2044.

Unless we can seriously transform our economy and drive much stronger growth, I think we’ll have to move faster than that.

Perhaps in tandem with the kind of straightforward income cap you are suggesting, we could take a middle path that could find some bipartisan support.

Greenshoots watch

The greenshoots story seems to be really taking hold now. We haven’t actually had much new data since last week.

But a really upbeat piece of commentary, ASB chief economist Nick Tuffley got a lot of media play.

In the ASB’s latest quarterly outlook, the bank’s economists are forecasting annual growth of over 2.5% in 2026 as improving cashflows lift household spending.

We do get a bit of fresh data this week – with new tourism and migration numbers from Stats NZ later this morning and card transaction data on Thursday.

On Monday, we get the last Selected Price Index for the year – a valuable read on how inflation for food, accommodation and travel is tracking.

Next Thursday we’ll get third third-quarter GDP. That will inevitably make the biggest splash in the media.

It might not tell us much, though – other than how bad the second-quarter slump really was (we’re expecting revisions to those figures).

I’ll look more closely at GDP – and whether it really matters – next week.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.