By BRIAN FALLOW economics editor
Larger business borrowers should almost certainly opt for fixed rather than floating interest rates now, even though the fixed rates on offer are higher than forecast floating rates, says BNZ chief economist Tony Alexander.
The key word is "forecast."
The gap between fixed and forecast floating rates is
about 50 basis points one year ahead, widening to a full percentage point seven years out.
But the average margin of error around those forecasts over the past 4 1/2 years (the period for which economists' monthly forecasts have been collected by Consensus Economics) has been 1.2 percentage points.
Given the difficulties of economic forecasting, especially in an economy as small and exposed to shocks as New Zealand's, such an error rate was no surprise, said Mr Alexander.
The biggest errors were made between August 1997 and August 1998, for the year ahead. "We were caught out by the severity of the drought, the Asian crisis, migration loss and, for some, the housing market weakness."
Even if that year is set aside, the average error has been 0.7 percentage points either way.
Economists have tended to be too high in their forecasts of interest rates when rates have been on the high side of neutral (which Mr Alexander, for the sake of argument, takes as 6.5 per cent for 90-day bank bills). When rates are below 6.5 per cent, as now, forecasts have tended to err on the low side.
Businesses and farmers were inclined to give somewhat more weight than they should to economists' forecasts when making interest rate decisions, Mr Alexander said.
But in the case of home loans, he doubts that the pundits' views are much of a factor.
One, two and three-year fixed mortgage rates are now 6.75, 7.2 and 7.6 per cent respectively, where the forecasts for average floating rate over the same periods are consistently higher at 7.5, 7.7 and 8 per cent.
"It's a complete no-brainer," Mr Alexander said. "We think fixed rates will rise over the next 12 to 18 months, so if one is to fix, it is best to do it now rather than wait.
"Second, fixed rates are currently below their average levels (for example three years at 7.6 per cent versus an average of 8.8 per cent since 1996), so one should lean towards fixing."
