Rising bank funding costs to put upward pressure on mortgage rates: RBNZ

The central bank's latest monetary policy statement (MPS) noted that mortgage rates have dipped slightly for most fixed terms and that rates offered on term deposits longer than six months have also declined.

“The margin between mortgage rates and wholesale interest rates is expected to return to more historically normal level as competition for term deposits continues and funding conditions for banks continue to tighten,” the MPS said.

“This is expected to see mortgage rates hold up relative to wholesale interest rates.”

RBNZ noted that wholesale interest rates have been volatile in recent months with rates of up to two years increasing compared to immediately before its last MPS in November last year, but that rates for terms longer than two years have fallen.

“The broad upward trend in spreads since the end of 2022 is likely to continue over the next few years,” it said.

“This is because increases in banks' cost of funding will likely continue to place upward pressure on mortgage rates in the years ahead, even in an environment of falling swap rates.

RBNZ expects the lagged impact of monetary policy tightening – it raised the official cash rate (OCR) from 0.25% to 5.5% between October 2021 and May 2023 – will continue to constrain the scale and speed of the housing market recovery, despite the ongoing additional demand coming from record net immigration.

“We project slower house price growth in 2024 following weaker price momentum in late 2023,” the central bank said.

“Mortgage rates have fallen by less than wholesale rates, causing a faster normalisation in mortgage rate spreads than previously assumed. We assume that house prices grow at a similar pace to that in the November statement over the medium term at around 6% per year,” it said.

“The reflects the lagged impact of high net immigration and lower interest rates later in the projection horizon.”

But the combination of declining investment in residential property, still restrictive interest rates and high net immigration mean heightened uncertainty about house prices.

RBNZ is projecting the OCR will remain at at least 5.5% through to the second quarter of 2025 at the earliest but that the OCR will be cut twice in 2025.

It expects household consumption will have declined by 3.5% in the year ending March this year but that it will recover gradually by mid-year.

RBNZ said the changes in government tax policy, including the return of interest deductibility of mortgage interest and returning the “bright line” test to two years from 10 years will put upward pressure on house prices because of increased demand from investors, but the impact will be “relatively small.”