“The era of lower-for-longer interest rates is at its end. Inflationary forces are here to stay, forcing up interest rates.” That was NBR’s take on what lies ahead even before the Reserve Bank reviewed the OCR on 18 August. At the same time, ASB economists were tipping mortgage interest rates could rise quicker than earlier forecast, predicting they could be two points higher by this time next year.
So, what does this scenario mean for the housing market? And will inflation be long-term or just a blip on the recovery radar?
If someone tells you they know the answers, it tells you more about the person than about what’s actually going to happen. Nobody knows. Modern economies are so complex that they can confound even the best and the brightest. Hence the oft cited, “an economist is an expert who will know tomorrow why the things they predicted yesterday didn’t happen today.”
The bedrock of economic theory says that if you increase the money supply, you get inflation. Yet since the GFC we’ve had loose monetary policy and cheap money — and very little inflation. It’s hovered around the range that central banks in the West have been targeting for the last 20 years.
Much of this has been due to the deflationary effects of globalisation, competition and technology; goods are cheaper to produce and easier to distribute. Take something as simple and universal as home entertainment. You used to have to subscribe to Sky for $90 a month and still hire a movie from a video store once a week. But now you’ve got streaming services competing against each other and for $10 a month you can watch as much globally produced digital content as you could ever imagine.
However, post-COVID disruptions to supply lines, pent-up consumer demand after months of lockdowns, and central banks pumping trillions of stimulus dollars into economies worldwide have led to the déjà-vu dread of a return to the hyperinflation of the recessionary ‘70s and ‘80s.
The oil shocks and price hikes of nearly 50 years ago devastated western economies. Only high interest rates instigated by the Federal Reserve curbed US inflation: between 1980 and 1983 it fell from 14.8% to below 3% — but the socio-economic cost was huge, with high unemployment and a housing market slump.
Are the extraordinary cost-push and demand-pull effects of the COVID recovery, and the massive supply problems, going to see the Reserve Bank pursue the same strategy here?
When we came out of lockdown, the demand for goods and services took off. In the face of an uncertain future and limited travel, people said, “let’s spend some money and do up the house or buy that car, that TV, that mountain bike we’ve always wanted.” They wanted to upgrade their home and lifestyle so that in the event of another lockdown, they could be surrounded by nice things. But seeking safety and security in their home pushed up demand for goods and services, creating scarcity, raising prices and fuelling inflationary fears.
The only tools central banks have to fight inflation is to raise interest rates and tighten money supply. If they do that, it will reduce asset prices — the market value of investments like houses, bonds and stocks.
By how much? Who knows! But higher interest rates will take the heat out of the housing market.
While no one knows the future, you can take the temperature. If interest rates have been at the lowest point they’re probably going to be, and asset prices are at the highest, you can safely assume the return over the next 10 years is going to be significantly lower than the return over the last ten years.
So, it’s really a time for caution and moving forward with respect for the fact that there is a lopsided risk that interest rates could rise.
My advice to borrowers is to do your maths on a higher rate of interest. People should be looking at their debt levels now and saying, “if we’re facing 5-6% interest rates, are we going to be able to manage that mortgage?”
Fortunately, most people will have some breathing space because banks have been more rational in their lending during this boom. Instead of chasing borrowers with easy credit, they’ve factored into their loans a margin in case people end up having to service their mortgages at a rate higher than those that have ignited the COVID spark.
It’s unbelievable to think you’ve been able to borrow $1 million for $25,000 a year — just $500 a week for a couple on a joint income of say, $160,000.
That’s been the upside of this market; the downside is it’s been harder for first-time buyers to secure a deposit because prices have escalated quicker than they can save. Ironically, in the days of double-digit interest rates, it was easier to save the deposit, but the mortgage was harder to service.
Houses were quite affordable in 2015 when you consider the price of a house relative to the time it took to save a deposit, how much it cost to service the mortgage, and how long to pay it off. They’re all the factors that come into play when calculating the affordability equation — it’s not just as simple as saying house prices are expensive relative to incomes as some commentators like to do.
It’s hard to predict when this balance will be as favourable as it was before house prices took off six years ago. This boom seems to have gone on forever but many of us have short memories. Before it started, nearly a third of the houses that came to market weren’t selling. And remember, there’s no real difference between property prices going down and going sideways for a long time.
In Wellington, house prices fell 10% between November 2007 and March 2008, then went sideways for six years. It was those years of stagnation and falling interest rates that helped us to achieve relative affordability.
But first-time buyers should be careful what they wish for. Remember, interest rates were at 9% in 2007, at the peak of the last boom. That would be a real problem for today’s borrowers. I think we’ll be okay if rates go a couple of points higher. That would dissipate demand and soften the housing market.
However, any gains for buyers would be offset by heavier borrowing costs. So, in the short-term, first-time buyers may not be any better off than they are now. For the bar-gain hunters among us, the only thing that appears truly cheap right now is money. If you are looking to refinance, there has never been a better time than now (August 2021) – but that could change!
