Article written by Hamish Pepper, Harbour Asset Management – 15th July 2021

• ASB increased all its fixed mortgage rates yesterday, including the highly popular one year rate by 0.36% to 2.55%. We expect other major banks to follow, likely marking the end of a multi-year decline in New Zealand mortgage rates.
• Many households will soon be exposed to these rates as almost 80% of outstanding mortgages are either floating (12%) or fixed for less than one year (65%).
• Further increases in mortgage rates are likely as the economic expansion supports a removal of monetary policy stimulus and higher bank funding costs.
• We think households in aggregate can manage higher rates. Debt servicing costs are historically low and there is some evidence that mortgage holders are currently paying off a greater proportion of principal, implying a buffer to rising rates.

The New Zealand mortgage rate decline of the past 7 years looks to be over. ASB announced yesterday that it would raise mortgage rates across all tenors, including the highly popular one year rate by 0.36% to 2.55%. Historical precedent suggests the other major banks will follow. Many households will soon be exposed to these mortgage rates as almost 80% of outstanding mortgages are either floating (12%) or fixed for less than one-year (65%), see figure below.

Further increases in mortgage rates are likely as our positive economic outlook augurs for a reduction of monetary policy stimulus and higher bank funding costs. The Reserve Bank of New Zealand’s (RBNZ) objectives of 2% inflation and maximum sustainable employment are close to being met. Core inflation is 2% and headline inflation is likely to have increased to almost 3% year on year in Q2. Measures of capacity utilisation in the manufacturing and building sectors are close to all-time highs. Record-high job vacancies suggest the unemployment rate will continue to fall from an already low 4.7%. The RBNZ hiking cycle should begin later this year and is likely to be larger than markets expect.

However, debt servicing costs are at multi-decade lows, and we think households in aggregate can manage higher rates. It costs the average household just 5.8% of its disposable income to service its debt, versus an average of 8.9% for the past 30 years (see figure below). In addition, data from the Westpac covered bond portfolio, which includes c.$4bn of residential mortgages, suggests that mortgage holders are currently paying off 15% of principal per annum, versus 13.8% prior to COVID-19, implying a buffer to rising rates (see figure below).

Furthermore, 1-year mortgage rates at about 2.5% are:

1. About 3.5 percentage points lower than the last high in 2014;
2. Lower than the average outstanding mortgage rate of 3%, suggesting borrowers can still roll on to lower mortgage rates; and

• Meaningfully lower than the 6.25% mortgage rate that banks use to assess a borrower’s ability to repay, implying the risk of repayment difficulty of default remains low.

We think mortgage rate rises of 1.5-2.0% are quite feasible over the next 1-2 years. This is likely to equate to a debt servicing cost in line with the average of the past 30-years.

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