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Low Down On Mortgage Rates

An over-supply of goods and raw materials used in their manufacture could mean softer prices and the risk of deflation, writes Jon Bolton

By: Jon Bolton

31 March 2016

TSB grabbed headlines in February when it came out with a 10-year fixed rate of 5.89%. That is a sensational rate for 10-year money and we’ve been helping a number of investors jump into it.

I’ve said before that interest rates will stay low for longer, but this latest round of extremely low rates caught me by surprise.

The rationale for lower rates has been: that we have huge debt that will put the brake on spending indefinitely and reduced consumption growth and oversupply would kill off inflation.

On the first point, even with a relatively small increase in interest rates, Aucklanders would struggle to service their monster-sized mortgages without cutting out discretionary expenses like eating out, coffee, and over-priced fashion labels made in China. Higher levels of debt will make consumers more price conscious.

The second point is far more interesting. During the 2000s, there was a gigantic increase in manufacturing capacity (particularly in Asia) in response to the biggest consumption boom in history. This spike in consumption was driven by post-war baby boomers, as well as historically low interest rates and debt growth. In New Zealand, debt growth ran at 15% per year during 2002-2006 and we saw mortgage debt grow from $100 billion to $200 billion over the past decade.

Just as we have manufacturing capacity peak, consumption will slow down as baby boomers retire. Coming in behind them, Generation X and Y cannot fill the void. They are a smaller generation by number and they are coming through saddled with debt.

High demand in Europe for credit-worthy debt has reduced long-term fixed mortgage rates to new lows

So, for the foreseeable future we face an over supply of goods and the raw materials used in their manufacture and that means softer prices and the risk of deflation.

The third factor I’ve never fully understood relates to all of this printed money around the world and the ensuing currency wars. Central banks have been trying in vain to competitively devalue their currencies.

Then out of left field, the surprise and something most economists thought impossible, has been negative interest rates on sovereign debt in the likes of Switzerland, Denmark, and Germany. Negative interest rates show a profound lack of confidence in the future of the Eurozone.

The catalyst has been the ECB printing money and buying member sovereign debt. Because there is no centralised debt in Europe, the ECB has been buying up a mix of member sovereign bonds. And that’s the catch. If Europe were to break up then investors wouldn’t want to be left holding Spanish or Greek debt. Relatively speaking they want to hold the debt of credit-worthy nations like Germany. But the Germans are running a surplus and not borrowing. And that excess demand has pushed rates below zero.

High demand in Europe for credit-worthy debt has reduced long-term fixed mortgage rates to new lows. In November, the ANZ raised $1 billion five-year covered Eurobonds priced in at 0.001% above wholesale rates.

However, it’s a limited opportunity for cheap money. To maintain stability, the Reserve Bank limits how much offshore money banks can access and domestic deposits remain relatively expensive.

I wouldn’t expect to see interest rates fall further without a decrease in the OCR and at this stage that seems unlikely. When it comes to mortgage rates, my view is to take the bird in the hand. To do anything else is speculation.

John Bolton is with Squirrel Mortgage Brokers www.squirrel.co.nz

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