Interest rate forecast – Where are interest rates heading?

There’s no missing it: Interest rates, like prices of everything else, have gone up.

And that makes it harder for property investors and all homeowners to pay the mortgage.

Why are interest rates up? It’s a hangover from Covid.

Low interest rates, high government spending and a tight labour market. Together these factors have pushed inflation up.

To fix it, the Reserve Bank increased the OCR to slow the economy down. What does it mean for property investors?

1. more expensive mortgages
2. worse cashflow for your investment properties.

And that’s why everyone is wondering: “When are interest rates going to start going down?”

In this article, you’ll get our forecasts on where we think interest rates will go here at Opes Partners. That way, you can make an informed decision about what to do with your property portfolio.

Our forecast for interest rates

Since 2022 we have predicted that the 1-year fixed mortgage interest rate will reach 7% in 2023.

This has proven correct. At the time of writing (November 2023), BNZ has the lowest 1-year rate at 7.25%.

Some banks have higher 1-year rates, but marginally.

Our current expectation is that this will fall to about 6.60% (-.60%), by this time next year.

We then think they’ll hit around 6% by October 2025 and then 5% from 2026 onwards.

But, of course, this is our best guess. No-one knows for sure. We economists expect these best guesses to be wrong.

Things happen worldwide that pull the economy in all sorts of directions. A few years back no-one predicted a pandemic, a war in Ukraine, and some of the worst flooding our country has seen.

But, here at Opes, we encourage investors to forecast the cashflow of their properties. So, we need to “guesstimate” where interest rates might head.

The exact numbers will likely be wrong, but it’s the general direction we’re trying to pick.

More from Opes Partners:

• How to handle higher interest rates... 4 strategies to manage your cashflow (Podcast)
  
• NZ property market - What's going to happen in 2023? (Video)
• The ultimate guide to mortgage interest rates (Article)

Where do the banks think interest rates will head?

ANZ says the 1-year interest rate likely peaked at around 7.3% in September 2023.

Like us here at Opes Partners, they think this rate will fall. By the end of 2024 they currently think the 1-year rate will be 6.8%. That’s not far off our guesstimate.

One thing to consider is how my predictions compare with other economists. Here is a graph that compares my 1-year interest rate forecast with ANZ Bank’s.

While our numbers have minor differences, they’re heading in the same direction.

The other major banks (BNZ, Westpac and ASB) don’t release fixed interest rate forecasts, so I haven’t included them above.

Instead, they release “swap rates”, which are effectively what it costs them to borrow money. Their predictions suggest that interest rates should come down too.

Why do you think interest rates will come down?

Interest rates have been increasing since 2021.

All the 1-year rates from the main banks are over 7% – with most sitting closer (or on) the 7.2% - 7.4% mark (November 2023).

Only a few years ago most bank’s fixed interest rates started with a 2.

So why have they increased? It comes down to inflation. That’s how fast the prices of things are increasing.

The Reserve Bank’s job is to keep inflation between 1 - 3%, but in June 2022 it shot up to 7.3%, so the Reserve Bank ramped up interest rates.

Now inflation is on its way down; in October it fell to 5.6%.

Inflation is still too high, but it’s heading in the right direction.

Most banks expect this trend to continue. That’s according to the NZ Institute of Economic Research (NZIER) survey. This shows that most banks expect inflation to be back within the 1-3% band by September 2024.

That’s the point where the Reserve Bank will likely let banks reduce interest rates.

Where will the OCR go in future?

The OCR (official cash rate) is the Reserve Bank’s interest rate. It influences other interest rates.

The Reserve Bank doesn’t think the OCR will come down until well into 2025.

That’s the point where they think they can take their foot off the break and let the economy move a little faster.

To be clear that doesn’t mean interest rates won’t come down until 2025.

The OCR influences interest rates, but banks don’t borrow from the Reserve Bank to lend you money for a mortgage.

Instead, the OCR impacts the wholesale money markets. And those money markets impact what it costs to borrow money from banks.

So, if people expect the OCR to come down soon, interest rates may fall even before the Reserve Bank makes a move.

That’s one of the reasons ANZ thinks interest rates will fall even if the OCR stays the same.

Where will interest rates head over the long term?

The future is uncertain. After all, it hasn’t happened yet.

Over the long term we assume the fixed mortgage interest rate will be 4.5%.

It won’t be 4.5% forever; sometimes interest rates will be higher, sometimes lower.

But here at Opes Partners we think 4.5% is the right number to use for 2 reasons.

#1 The Neutral OCR is estimated at 2%

Looking back over the last 10 years, the average difference between the OCR and the 1-year fixed rate is about 2.5%.

There are differences, but the pair follow the same broad trend over time.

The Reserve Bank suggests that the long-term neutral OCR is around 2%.

That means that when they are neither trying to speed up nor slow down the economy, the OCR should be around 2%.

If the long-term neutral OCR is 2%, then over the long term the 1-year rate should hover around 4.5%.

#2 The long-term average 1-year rate is around 4.5%

Over the last 10 years, the 1-year fixed interest rate has averaged 4.48%. This represents a “more normal” level of interest rates.

Bear in mind it’s not a perfect forecast, but it’s a helpful starting point to use as an assumption.

How long should I fix my interest rate for?

At Opes Partners, we typically recommend fixing for the 1-year rate.

The 1-year rate is the most expensive rate today, but once interest rates come down, today’s longer-term rates will look expensive.

In other words, we expect the 1-year rate to deliver short-term pain for long-term gain.

If you take the 5-year rate today, you risk locking in a rate that looks good today, OK in a year, and expensive in 2 years.

So, in our view, there is more risk in fixing for too long than fixing for too short.

What if your interest rate forecast is wrong?

Sometimes investors will ask, “What happens if your forecasts are wrong?”

They probably will be. They are a best guess today and often change – because the world changes. These things cannot be predicted with 100% accuracy.

More importantly, economists expect to be wrong. It comes with the territory.

So, if you’re a conservative investor, either:

• run the numbers on your portfolio, factoring in higher rates in your forecasts, or

• lock in for a longer interest rate. It’ll likely cost you more over time, but you are paying for certainty.

• Also, remember that banks stress test your mortgage application at higher interest rates.

So (at least in the bank’s eyes), if you can get a mortgage, they have the confidence that you are able to afford it.

You can also stress test your lending at higher interest rates.

Download our Return On Investment spreadsheet to check your numbers.

This is a good tool to aid investors when running the numbers on an investment property.