Interest Rate Predictions – Where Are Interest Rates Heading?

LM b W

Laine Moger

Journalist and Property Educator for 6 Years
Introduction

There’s no missing the fact that interest rates are going through the roof. And banks are continuing to increase them week-on-week.

In fact, during the last 6 months, mortgage interest rates are up over 50%.

The knock-on effect for property investors is twofold – more expensive mortgages, and the loss of cashflow from investment properties (compared with what otherwise would have been the case).

So investors are likely wondering: “Where are interest rates going to go over the next few years?”

So, in this article you’ll discover our predictions for where interest rates are going to be over the next couple of years, so you can make decisions around your property portfolio.

Rising Rates

Why Are Interest Rates Climbing All Of A Sudden?

To begin, we need to first go over what we’ve seen over the last 10 years.

Why? Because in doing so we can catch a glimpse of where we might be heading in the future.

Since 2014 interest rates have been on the decline.

At their height, the 1-year mortgage interest rate hit 6.06%, according to interest.co.nz. This fell steadily to an average of 2.2% by mid-2021.

Interest Rate Predictions Kain 1 006

But, since July 2021, we have started to see a sharp move upwards. In the space of the last 4 months the average 1-year rate has moved up to 3.4%. A whopping 1.2% increase.

Why?

Why Are Interest Rates On This Rise? Is This All Covid’s Fault?

In March 2020 the entire country experienced its first nationwide lockdown as a response to a burgeoning Covid-19 pandemic. Shortly after we saw interest rates plummet from the 3.5- 4% down into the 2.2% range.

This drop was specifically to help the economy during the pandemic. Now, some 18-plus months later, things are returning to normal and we are beginning to see a sharp recovery from that record low. Yes, interest rates are increasing, but off a record-low baseline.

Interest Rate Predictions Kain 1 015
Rates Explained

So, You Still Haven’t Explained Why Interest Rates Are Rising So Fast?

Currently, there are two factors steering the course of interest rates upwards. And they both have to do with the Reserve Bank Governor, Adrian Orr.

Factor #1 – ‘Renormalisation of Monetary Policy’

The first factor is called a “renormalisation” of monetary policy.

That’s a big technical word for interest rates returning to normality, like the rest of us are trying to do.

This factor is a direct result of Covid, because when we first experienced those lockdowns it looked as though Covid-19 was going to have a negative impact on our economy.

We were staring down the barrel of massive unemployment as well as massive house price drops.

So, to combat this the Reserve Bank severed interest rates, opening the floodgates to all the buyers to keep people spending.

It reduced the Official Cash Rate (OCR) and printed money through the Large Scale Asset Purchasing Programme to buy up government debt.

On top of this it lent money to the banks at very cheap interest rates. This was to encourage the banks to lend that money to people buying properties or borrowing for business.

The good news is that the disaster predicted before the pandemic didn't happen in practice. And the Reserve Bank and Government support kept unemployment low, and the economy relatively healthy.

They did such a good job that unemployment is now lower than it was before the pandemic started. Unemployment hit just 3.4% in September 2021, compared with 4.2% in March 2020.

In fact now the economy is starting to overheat. And inflation – prices going up – is rearing its head.

Now that the job is broadly done, it’s time for the Reserve Bank to step back from actively trying to stabilise the economy and bring interest rates back to a more normal level.

Factor #2 – The Reserve Bank Needs To Start Fighting Inflation

The second factor is inflation – it’s skyrocketing, which is a result of this overheating economy.

Over the last 10 years the inflation rate has been, on average, 1.48%.

This is on the low end, since the Reserve Bank is required to keep this rate between 1% and 3% on average – and usually aims for an average of 2%.

But annual inflation was up to 4.9% in the last quarter. This means it’s more than 3x the amount of the last 10-year average. The Reserve Bank had to take action.

The interest rate hikes aim to cool the economy back down to keep inflation in the 1-3% band.

Our Predictions

So What Are Your Interest Rate Predictions?

For any prediction, a good baseline to start with is the long-term average.

Why? Because when you’re trying to figure out where things are going to go in the future, this can act as a baseline, and then you can adjust your expectations from there.

There are two parts to our prediction. Firstly, what we think they’ll hit (i.e. “how much” interest rates will be. The second part is when we think they’ll come into play (i.e. “how fast” we’ll hit them).

How Much – How High Will Interest Rates Go?

For example, let’s look at the 10-year average for interest rates on mortgages.

The 1-year fixed interest rate has been sitting at 4.45% on average for the last 10 years.

If we’re talking about moving back to a “more normal” level of interest rates, this is a good place to start.

This means, for investors running the numbers on their portfolio, you should start thinking about moving up to a 4.45%-4.5% interest rate, from current figures.

Although this is just an average, it fits well with the data the Reserve Bank has released.

How Fast – How Quickly Will Interest Rates Keep Increasing?

But, I hear you ask, how do we figure out how quickly this will move up to 4.45%-4.5%.

The Reserve Bank can give us a clue … and it’s all to do with the OCR.

The OCR is the interest rate that the Reserve Bank has full control over. It’s set by the Reserve Bank and is tied to what the banks are charged for some of their short-term lending.

Looking back at our 10-year average, you can see the OCR and the 1-year fixed interest rate move almost hand-in-hand.

The pair follow suit through the increases and dips over time.

So, taking the forecast the Reserve Bank has released about how they predict the OCR will behave over the next few years gives us a great insight into how the 1-year fixed will follow suit.

And, according to these forecasts, they say the OCR will tip just over 2% by the time we make it to 2024.

So, a quick increase and then a levelling out.

Over the last 10 years there has been an average of a 2.5% margin between the average 1-year fixed interest rate and the OCR.

So, if we plot what we know about the behaviour between the OCR and the 1-year fixed, back over the Reserve Bank’s forecast, you can see we are heading back to that 4.5% mark over the next couple of years.

When you’re at home running your numbers on your investment properties start with current rates, factoring in a 4.5% interest rate, moving up to that point by about late 2023.

Interest Rate Predictions Kain 1 046
What If

What If Your Interest Rate Predictions Are Wrong? I Can’t Bank On This Prediction Being Accurate.

As we’ve said earlier, forecasts are just forecasts. Predictions are just predictions. So, there are some reasons to think we might overshoot this 4.5% figure.

For example, what if we get to the 5.5% mark?

If you’re a conservative investor, run the numbers on your portfolio factoring in higher percentages in your forecasts.

The idea here is to stress test your lending ... just in case we do see those interest rates.

For example, if you find out you aren’t going to be able to afford the lending you currently have at 5.5%, it’s definitely worth your while being prepared for that in advance.

You can then either look to fix your lending in for a longer period e.g. 5 years. Or, look to pay down debt more aggressively.

Here at Opes Partners we have an inhouse ROI (Return On Investment) Spreadsheet. This is a good tool to aid investors when running the numbers on an investment property.

Conclusion

So What Are Opes Partners’ Interest Rate Predictions?

Right, after all that jabber, what’s the short answer to the initial question: What is Opes Partner’s prediction for interest rates?

The answer: 4.5%-ish. Give or take a bar or two.

This prediction is from two things.

The first is from the 10-year average for both the 1-year fixed term interest rate, and for the OCR (the two seem to behave in parallel).

The second is how the average plots against the Reserve Bank’s own predictions for the near future.

That said, these are forecasts, so aren’t set in stone and are subject to change. We can’t see into the future to give an exact figure, as much as we would like to.

So, to be on the more cautious side, when you’re running your numbers at home to see how your personal lending is going to fare over the next few years, do a stress test for a prediction a few notches above just to give yourself a good idea of where you’re sitting.

LM b W

Laine Moger

Laine Moger has been a journalist and reporter for the last 6 years. She previously worked for Stuff, The North Shore Times and Radio NZ. She has a Bachelor of Communications (Honours) from Massey University and a Diploma of Journalism from the London School of Journalism.