Bernard Hickey: Dull inflation history predicts future of mortgages

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

Academic debates about history and economics send most people to sleep very quickly. But what if you could be more confident about fixing or floating your mortgage by knowing who would win these debates?

For millions of New Zealanders with term deposits and mortgages, the history of inflation versus deflation is crucial. More than $190 billion of mortgages and more than $100 billion of term deposits ride on the outcome.

This week's increase in the Official Cash Rate cast this debate in a bright spotlight.

Reserve Bank Governor Alan Bollard lifted the OCR by 25 basis points to 3 per cent and said he would lift it again soon. But he also said future increases would not be as fast or as high as he had previously forecast because of a softening of growth in the global and local economies.

Bollard forecast on June 10 that the OCR was likely to rise to around 5.75 per cent by late 2012 as he withdrew stimulus from the economy to control inflation pressures. The Reserve Bank's projections for the 90-day bill rate implied most of that increase would happen over the next year. Economists are now saying Bollard may hike by a further 50 basis points to 3.5 per cent before pausing in December. Some suggest he may eventually raise it to 5 per cent. That would mean floating mortgage rates top out at about 8 per cent late next year.

That's important for those choosing to float their mortgage. Given that banks are likely to increase their variable rates to around 6.2 per cent over the next week or so, many will be wondering if the two-year fixed rates of about 7 per cent make sense. It is possible those longer-term fixed rates could fall again to around 6.8 per cent, given wholesale interest rates fell around 10 basis points after the OCR announcement.

This is where the debate about deflation and inflation becomes crucial.

If you believe that all the money printing going on in the US and Europe will eventually spark inflation as it did during the 1920s and 70s, then you would expect the OCR to rise quickly next year and make the fixed deal more attractive. If you think the headline inflation spike coming later this year because of the GST increase and the ETS costs will cause longer-term inflation then the fixed deal looks sexier.

The debates about hyperinflation of the 1920s suddenly sound interesting.