Mortgage rates may rise after wholesale rates bumped up, post-Budget. Photo / Getty Images
Budgets have tended to be predictable affairs for the financial markets, but this week’s release has proven the exception to the rule.
Wholesale interest rates rose sharply in response to moves outlined in the Budget, which has been dubbed by rating agency S&P Global as “expansionary”.
The market seemingly agrees with that tag.
As they see it, expansionary also means inflationary, so wholesale rates have responded accordingly.
The two-year swap rate, which has an influence on home mortgage rates, jumped from 5.19 per cent to 5.48 per cent following the Budget.
In the long end, bond yields were up because the supply of government bonds coming on stream was far larger than was predicted.
Two-year government bonds traded at 5.06 per cent from 4.78 before the release, while 10-year bonds went to 4.40 per cent from 4.24 per cent.
In bonds, prices move inversely to yields, so the spike means bond prices have come down substantially, reflecting the likely impact of more supply.
In total, the bond programme has increased from the half-year update by $20 billion to $148b over the five-year forecast period to 2027.
At the short end of the interest rate curve, the market and some economists have re-appraised the risks, calling for a higher official cash rate (OCR) than was previously forecast.
BNZ economist Doug Steel said the Budget was far more expansionary than expected.
“There was more borrowing, and that led to higher interest rates across the bond and the swaps curve,” Steel said.
“Essentially, for the Government to borrow that much more, investors are requiring much more money,” he said.
“And the idea that the Reserve Bank may have to lift the official cash rate a bit more has seen the curve flatten, so the shorter end is moving higher than the longer end,” he said.
Steel noted that Budgets in recent years have not tended to move the market by much.
“This one was a bit different.
“Judging by market prices, it did take a few by surprise,” he said.
ANZ market strategist David Croy said the dual issues of a more expansionary Budget, and the prospect of more bonds coming on stream had elevated interest rates.
The Reserve Bank, at the release of Wednesday’s monetary policy statement, is expected to increase its official cash rate by 25 basis points to 5.5 per cent.
Expectations of where the rate will peak have changed radically over the week, and market pricing now suggests a high point of nearly 6 per cent by August-October.
“The Budget has led people to reassess assumptions as to where the OCR is headed,” Croy said.
“It has also shifted the supply/demand balance in the bond market, and that’s had more of a longer-term impact on bond yields,” he said.
Harbour Asset Management fixed interest strategist Hamish Pepper said banks – depending on how they choose to react to the wholesale market – could push home mortgage rates higher still.
“It puts pressure on interest mortgage rates to rise,” Pepper said.
“Obviously, wholesale markets are just one place where banks can source funding, the other being retail deposits.
“Retail rates have been pushing higher and that’s likely to continue.”
But banks, when deciding on whether to raise their mortgage rates, would have to consider the demand for mortgage finance is weak.
“We know that demand for borrowing is not high, particularly in the mortgage space, so that’s the other side of it.
“Banks may see higher funding costs, but to pass them through mechanically into a market where there is not necessarily the demand for lending may not be what they choose to do from a strategic point of view.”
Banks have changed their view on where the official cash rate will go.
ASB now sees the Reserve Bank raising the rate by half a percentage point to 5.75 per cent.
The bank is an outlier on that forecast, but markets are nevertheless pricing in a higher likelihood of a half-point hike next week.
While the prospect of increased supply may have spooked the bond market, it didn’t show in today’s routine $400 million government bond tender, which was very well supported.
The NZ Debt Management – part of the Treasury – said the offer of May 2032 bonds attracted $769m in bids, more than five times the $150m on offer.