Yesterday the Reserve Bank accelerated the monetary policy easing cycle, cutting the official cash rate (OCR) by 50 basis points to 4.75%. Markets had priced in a cut of around 50 basis points, although the consensus among analysts was more divided between 25 and 50 basis points. Most retail banks had shifted their forecasts to a 50-basis point cut following the release of NZIER’s Quarterly Survey of Business Opinion on 1 October.

Our view remained that a 25-basis point cut was the option most consistent with the Reserve Bank’s previous outlook. It also made sense given that consumer price inflation data will be released next week, leaving the bank time to react to this data at its final Monetary Policy Review for the year in November. However, it would also be more sensible for reviews to be scheduled shortly after key economic data releases, as opposed to a week before!

This article looks at how mortgage rates have evolved compared to the OCR this year, how borrowers are currently structuring their mortgages in anticipation of future interest rate cuts, previous easing cycles, and how we expect this cycle to unfold over the next few months.

Kiwibank was confident of a 50-basis point cut, as it lowered floating mortgage rates by this amount even before yesterday’s announcement by the Reserve Bank.

The move was a competitive or marketing play based on Kiwibank’s messaging. With very few buyers in the housing market due to high mortgage rates and job security concerns, competition among banks for limited lending remains hot.

Between the start of this year and the end of September, the average one-year mortgage rate offered by retail banks had dropped 0.99 percentage points (see Chart 1), whereas the OCR had only seen a 0.25 percentage point reduction. Wholesales swap rates have fallen much further, by more than a percentage point for 1-3-year swaps, reflecting increasing bets by wholesale financial markets that the Reserve Bank would cut interest rates more rapidly than previously signalled.

Almost half of new mortgage lending in August was for a term of six months (excluding floating), and a massive 83% for one year or less. With further interest rate cuts expected sooner rather than later, buyers are opting to fix short, despite the additional immediate pressure this choice places on household budgets. Paying higher interest rates in the near-term means that people might be able to refix at considerably lower rates in 6-12 months’ time.

Before the August review, the OCR had not been cut since March 2020, when the OCR went from 1% to 0.25% in the face of uncertainties around the escalating COVID-19 pandemic. That easing cycle had started in May 2019, when the OCR was first cut from 1.75% to 1.5%.

The current easing cycle is certainly much different from the 2019/20 cycle. This time around, the OCR has a much higher starting point of 5.5%, almost four percentage points above the previous peak. It will also be much different from the post-GFC easing cycle, when interest rates were cut from a record high of 8.25%.

We also don’t expect interest rates to return to levels seen during the decade to 2020. The mid-point of the Reserve Bank’s long-run neutral OCR models, being a rate that neither stimulates nor dampens the economy, is estimated to be around 3.0%. The average OCR that was seen between 2010 and 2020 was approximately 2.5%, reflecting unusually weak inflationary pressures over a sustained period. This low inflation was due in part to technological advancements and productivity improvements in the Chinese economy, leading to China effectively exporting disinflation to the rest of the world.

Key pieces of economic data before the next OCR review in November are the consumers price index (16 October), unemployment (6 November), and inflation expectations from the Reserve Bank’s Survey (11 November).

We expect the Reserve Bank to take a measured approach in November with another 50-point cut, as it breaks for three months before its next review in February 2025. However, a 75-basis point cut in November is not out of the question, as the Bank offered little forward guidance in yesterday’s statement. Even then, the Bank has shown its willingness not to be constrained by its own previous statements and forecasts.

With next week’s inflation data likely to show headline inflation close to 2%pa (we are picking 2.2%pa), the Bank’s easing cycle is also looking increasingly behind where it should be, given the OCR remains well above neutral and is therefore still constraining economic activity. The Bank was too slow in raising interest rates when inflation was accelerating, and its questionable forward-looking ability means it might now also have to play catch-up on the way down, and implement bigger interest rate cuts than would otherwise have been needed.