Movements in mortgage rates have been peculiar since the start of 2023. Despite the 50-basis point increase in the official cash rate (OCR) in February, pressure on retail mortgage rates has generally been in the other direction – downwards. So, what’s going on, and what do current events mean for the future pathway for mortgage rates? And with low sales volumes, more distressed owners, and stubborn seller expectations, how will housing market outcomes evolve throughout the coming year and beyond?

We recognise that there is not a one-to-one relationship between the OCR and mortgage rates, especially in the case of fixed mortgage rates. Fixed mortgage rates can effectively price in future OCR moves ahead of time, meaning that if the Reserve Bank simply moves in line with market expectations, there might be no change in fixed mortgage rates.

To frame the market dynamic in a different way, fixed mortgage rates are also influenced by movements in longer-term wholesale rates, which reflect a whole bunch of financial market considerations around medium-term expectations for economic growth, inflation, and future monetary policy settings. These expectations evolve over time as new information about the economy becomes available, of which the Reserve Bank’s current monetary policy settings and forecasts are only one part.

Perhaps what has been most surprising about mortgage rate movements so far in 2023 has been the floating rate, which has risen by less than half the magnitude of the Reserve Bank’s 50-point OCR increase in February. This smaller increase suggests that retail banks have absorbed a large chunk of the most recent OCR rise. Chart 1 confirms that this trend has been in place for the last 12 months, taking the gap between the OCR and mortgage rates to its smallest since 2016.

Yesterday’s 50-point increase in the OCR in part reflected the unresponsiveness of retail interest rates to the Reserve Bank’s previous tightening this year. The Bank’s Monetary Policy Review included the comment that “wholesale interest rates have fallen significantly since the February Statement… [so] a 50 basis point increase in the OCR was seen as helping to maintain the current lending rates faced by businesses and households”.

A key contributing factor to the recent disconnect between the OCR and retail mortgage rates is likely to be the lack of activity in the housing market. As Chart 2 shows, the annual house sales total has plunged from 100,100 in mid-2021 to under 60,000 in the latest data to February 2023. Sales volumes are now at their lowest level since 2011, and there is a strong likelihood that later this year they slip below the 2009 low of 53,220 recorded during the Global Financial Crisis.

Despite house prices continuing to decline, and banks therefore likely to be lending on an asset that is falling in value, there appears to be increasing competition in the mortgage market. A month ago, BNZ and ASB were reportedly offering one-year rates at 4.99% to new customers, which was about 1.5 percentage points below the carded one-year rate. It appears that the banks have lending targets to meet, and with sales volumes at 11-year lows, meeting those targets has become incredibly challenging. It is likely that this dynamic and the associated lack of demand among borrowers is also influencing the banks’ standard mortgage pricing.

Our modelling of future mortgage rates suggests that, under more “normal” market conditions, there could still be another 50-75 basis points of increases for fixed mortgage rates from current levels. This forecast is premised on two further increases taking the OCR to 5.75%, and an increase of up to 40 basis points in longer-term wholesale rates. Given the dynamic in retail rates since the start of this year, the total increase in mortgage rates might not be of this magnitude.

Less pass-through into retail rates would be welcome news for households as they continue to roll off the ultra-low interest rates from during the pandemic. It would also mean that the effectiveness of the final few OCR hikes in the Reserve Bank’s tightening cycle could be diluted. The risk of the Reserve Bank “overdoing” the tightening during the first half of this year then diminishes, with a commensurate increase in the possibility that inflation is sustained at higher levels for longer and takes longer to bring back under control.

Chart 3 demonstrates the outsized proportion of mortgage debt that is set to roll off lower fixed rates over the coming 12 months. At about 50%, it has eased significantly from the 66% reached in June 2021, when mortgage rates were at their low point and one-year rates looked particularly attractive.

More detailed data shows that the spread of fixed-rate expiries is spread reasonably evenly throughout this year, with a slightly larger proportion of loans coming up for renewal between about June and August. Analysing the data suggests that most of these loans will have been fixed for one year, meaning that even if fixed rates remain at current levels, mortgage holders will be facing an interest rate about 1.3-1.4 percentage points higher than they have been paying. However, that increase pales in comparison beside the 2.7 percentage point increase they suffered between July 2021 and July 2022.

Recent reports from Centrix have noted an increase in households getting behind on their mortgage payments. Because Centrix’s published data only goes back to 2017, we’re unable to benchmark the latest increase against the Global Financial Crisis, meaning it’s difficult to know how significant the latest increase is. However, at 1.3% of households, we note that the current rate of home loan arrears is below the rates that prevailed at any time during 2017 and 2018. Nobody was wringing their hands about mortgage defaults at that point in time.

This lack of widespread genuine distress in the housing market is reinforced by data on the “pre-sale” housing market. The stock of properties for sale has plateaued since June last year, despite sales numbers continuing to fall away. Although the number of new listings coming onto the market has been edging lower, it has not fallen away by as much as sales volumes. The steady stock of properties for sale suggests that an increased proportion of homes are being withdrawn from the market when they are unable to meet the vendor’s sales price expectations. These withdrawals would not be occurring in situations where vendors are effectively being forced to sell due to financial distress caused by sharply higher mortgage rates. Instead, they’re being removed because sellers can choose not to accept lower prices at present.

The disconnect between sellers’ price expectations and achievable sales prices is reinforced by the limited decline in asking prices compared to final sales prices. Since the December 2021 quarter, REINZ’s house price index has declined 15% from its peak (seasonally adjusted three-month average). In comparison, average asking prices for properties have only eased by 7.2%. There was a similar disconnect in 2007-2009, when sales prices fell 11% but asking prices only dipped 4.2%.

Essentially, we see the bulk of house sales occurring now as being due to exogenous non-market factors, such as death or divorce. Even with interest rates having risen substantially, the vast majority of homeowners are under no compulsion to sell, so if they aren’t offered the price they want, they simply won’t make a deal. This illiquidity in the housing market is likely to persist for several years, given that sellers’ price expectations have been conditioned by the massive ramp up in house prices during 2020 and 2021.

In summary, there is little prospect of a significant improvement in the housing market any time soon. Whispers of a stabilisation in house prices or a pick-up in buyer interest appear premature, and yesterday’s lift in the OCR by the Reserve Bank looks likely to push up servicing costs again and further reduce affordability for potential buyers. The Bank is determined to rein in inflation and quell excess demand across the economy, and unwinding the housing market excesses that occurred during the pandemic remains a key part of that broader economic correction.