How the economy affects home loan rates

Covid-19 and the economic recovery from lockdowns gave many people a sharp reminder of how the wider economy can affect home loan interest rates.

In the space of 18 months, we saw home loan rates shoot up from record lows of less than 2.5% to nearer 7%.

But how does the wider economy affect mortgage rates, and how can you keep abreast of what’s happening?

Why does it matter?

The Reserve Bank is tasked with keeping inflation within its agreed target band of 1% to 3% over the medium term.

When inflation is too low, the Reserve Bank relaxes interest rates, giving households and businesses more money to spend and hopefully firing up the economy a bit.

When it is getting too high, as in recent years, the Reserve Bank raises the official cash rate.

This is a deliberate measure to slow the economy, reduce what people have available to spend and help tamp down inflation.

The official cash rate drives a significant part of the banks’ cost of lending.

That means, when the OCR goes up, home loan interest rates tend to follow.

Banks also get their funding from wholesale and offshore markets. The cost of borrowing on these markets is also driven by the movements and expected movements of central banks around the world.

It’s not just about what happens here. Although it can influence only domestic inflation pressures, the Reserve Bank also keeps an eye on international price increases that push through to the New Zealand market via tradeable inflation.

Do we all need to become economists, to keep up with what’s happening?

There are lots of ways to keep an eye on what’s going on in the economy, without having to spend too much time in the details.

Stats NZ publishes quarterly updates on important stats such as inflation, gross domestic product, employment and migration – all factors that can drive the economy. Beyond the data itself, all local media provides analysis of what it means.

The Reserve Bank also publishes its monetary policy statements, which give an overview of its thinking about the economy.

If things are looking softer, you might think a shorter fixed rate term may be appropriate since banks have a clearer view of the immediate future, but if the economy is starting to look stronger, a longer fixed term might seem a better option. As always, this depends on your objectives since suitable fixed terms depends on several factors that are not just based on interest rate forecasts.

But while it helps to have an idea of where things might be headed when you’re thinking about your loan strategy, it’s often not a great idea to try to strategise too much. While macro trends might be clear-ish, near-term movements can be unpredictable. Even people whose job it is to make predictions can get it wrong.

If you’re making decisions for your own situation, it’s generally a good idea to think about what suits your own circumstances best – not what is going to line up perfectly with economists’ predictions for the future.

The housing market

Interest rates are a significant driver of house prices. When interest rates are lower, people can afford to service a higher loan, which can help to push values up. When interest rates are high, or seem to be tracking higher, people are often more reluctant to spend.

The wider economy also affects house prices because people who are worried about the future of their jobs or their business may be less willing to commit themselves to the purchase of a new asset.

Sometimes, banks may be more wary about lending in an uncertain economic environment.

Ready to talk?

If you’re wondering about your interest rate strategy, pondering your mortgage or just have questions about the current environment, get in touch with us. We are involved with the market every day, which gives us an in-depth understanding of what’s really happening, and what you might need to know.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.