Interest Rates in New Zealand – How Does it Work?

We wrote recently about the Reserve Bank of Australia cutting the official interest rate and of course near neighbours, New Zealand's Reserve Bank has cut their interest rates. The effect in each country is quite different though.

An interesting vlog by well-known New Zealand commentator Bernard Hickey explains why the RBNZ is Impotent and no that's not sexist - they are all men over at the Reserve Bank even if Helen Clark is the Prime Minister, at least until the November election.

Hickey's argument is that the NZ's Reserve Bank doesn't have much control over the mortgage lending market, as say its counterpart in Australia does: in fact he uses the metaphor of trying to turn a supertanker compared to steering a speed boat. Nearly 90% of all New Zealand's mortgages are fixed rate: fixed rates have been less than floating rates for at least the last 7 years. Most NZers will fix their mortgage for around 2 years. So it takes around 2 years for the effect of an interest rate cut or hike to filter through.

Pasha: Steering Problem with Large Ship

In contrast in Australia only around 25% of mortgages are fixed rate, so a change in the RBA interest rates has an immediate effect on the home-owner's wallet and immediately slows the economy.

Why the different proportions of fixed rates? NZ has what is known as a negative yield curve, love the economic jargon, which simply means that fixed rates are cheaper than floating rates: so the public sensibly minimises their borrowing costs and fix their mortgage rates. What drives the lower fixed rates? Essentially the banks borrow overseas to fund the fixed rate mortgages and now that overseas interest rates are increasing, and have been some time that money is becoming more expensive. So although the RBNZ may be reducing interest rates, the banks are in fact increasing some of their fixed rates.

So how could the Reserve Bank in New Zealand gain control of their own home lending market again? Well they could slash the rate so low that borrowers would break their existing fixed loans to take advantages - a fairly unlikely circumstance.

Possibly more likely as overseas investors become more nervous of NZ's high level of debt, they will possibly see NZ a less attractive place to lend money to.

So if you wonder why NZ has some of the most dramatic highs and lows in the property market - its this sort of economics that makes it interesting to be a property investor in New Zealand.

Not all is doom and gloom though: the Economist is still quoting New Zealand's house prices as the eighth strongest in the world.

Photo: by Antwelm showing the Pasha which grounded in Newcastle, NSW last year.