Mark Lister: Reserve Bank signals lower interest rates, but mortgage relief may be limited

THREE KEY FACTS

• Interest rates are expected to decrease, but mortgage rates may not drop as much as anticipated
• The Reserve Bank projects the OCR to settle around 3% by early 2027
• Borrowers should prepare for mortgage rates of around 5%, reflecting a new normal for borrowing

Mark Lister is investment director at Craigs Investment Partners.

OPINION

Interest rates are headed lower, which will take the pressure off household budgets and give borrowers a reprieve.

The bad news is that they might not fall quite as much as some are hoping.

With that first rate cut under its belt, the Reserve Bank has several more in the pipeline.

Its projections suggest the Official Cash Rate (OCR) will keep falling from here and settle at about 3% by early 2027.

Financial markets also expect the policy rate to land at those levels, although they see it getting there a little sooner.

The OCR is like the Reserve Bank’s brake or accelerator pedal, and its key tool to influence activity and inflation.

The “neutral OCR” is the level where the economy is in balance, and it isn’t being sped up or slowed down.

It’s difficult to pinpoint exactly where this tipping point is, but it’s an important concept for policymakers and the rest of us.

Historically, the Reserve Bank has thought it to be about 2%, in line with its inflation target.

Ignoring the pandemic and its aftermath, that’s roughly where the OCR has averaged in recent years.

In the decade preceding Covid, the OCR fell as low as 1% and pushed as high as 3.5%.

It averaged 2.3% over the entire period and spent eight of those 10 years below 3%.

Today, the Reserve Bank believes the long-term neutral level of the OCR is 2.8%, up from 2.3% a year ago and above the historical estimate of 2%.

Don’t get ahead of yourself, warns Mark Lister. If the neutral OCR is higher than it used to be, the “new normal” for mortgage rates will be too. Photo / 123rf

It’s not alone.

The Federal Reserve in the US has also been revising its estimate of the long-run policy rate higher.

It sees it at 2.8% as well, compared with 2.5% at the beginning of the year.

Economists can’t precisely calculate where neutral is at any given time, but most experts agree it’s higher than it used to be.

Globalisation moving into reverse, higher government debt, demographics and climate change action have been contributing factors.

For the typical homeowner, the upshot is that mortgage rates might not fall quite as much as they’d like.

Over the past several years one and two-year mortgage rates have been, on average, 2.3 and 2.4% above the OCR.

This gap widened during the ultra-low interest rate Covid period, while it’s been much narrower since the OCR pushed above 5% last year.

Where it goes in the coming years will depend on several factors, including how competitive the mortgage market gets.

However, history would suggest borrowing rates for these popular mortgage terms will be about 2% higher than the OCR, give or take.

Financial markets see the OCR falling to 4% by April 2025, which implies mortgage rates of about 6%.

Two years from now, it is expected to have reached its 3% nadir, which implies mortgage rates of about 5%.

That’s a big fall from the 7%-plus peak, but it’s well above that of the crazy Covid era as well as the four years before that.

If 5% is indeed as good as it gets, the coming period will more closely resemble the post-GFC years of 2009 to 2015.

Back then, the OCR oscillated within a range of 2.50 and 3.50% and it averaged 2.75%, almost bang on the latest estimate of where neutral is.

Over those seven years, the one-year mortgage rate averaged 5.1%.

It’s true, interest rates are headed lower and borrowers are right to feel more upbeat, optimistic and encouraged about what’s ahead.

However, don’t get ahead of yourself. If the neutral OCR is higher than it used to be, the “new normal” for mortgage rates will be too.

Mark Lister is investment director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.