Keep on floating

By Michael Wilson

The joys of inertia. Just letting the floating mortgage drift on year after year has proved to be a brilliant strategy.

For those mortgage holders out there the best policy has been to ignore all the “expert” advice which insisted interest rate rises were inevitable. Moving to a fixed mortgage rate was highly recommended as the Reserve Bank would inevitably raise the OCR – Official Cash Rate – as inflation kicked up and the economy started to recover. And I must admit when asked for advice by mortgage holders as to the merits of fixed versus floating I would usually fudge it by saying the best policy is to have a bit of both. That way you would be half happy, half grumpy. And that usually is a reasonable strategy as economic forecasting is not exactly easy.

Economists, who have spent thousands of hours studying the dismal science, can and frequently do get things horribly wrong. There are so many variables involved in an economy that forecasting is really not much different to tossing darts at a board. Will you hit the bullseye or triple one? It can be that random.

So when the Reserve Bank Governor Dr Bollard said a rate rise will happen “over the coming year or so” I thought to myself the anti-Nike approach,  “Just Don’t Do It”,  has turned out to be a stroke of genius. Or luck! Who could have predicted Christchurch’s February earthquake which prompted Dr Bollard to cut the OCR by half a per cent? It was a devastating and utterly random event. (I don’t even think Ken Ring predicted it!) That 50 basis point cut meant the OCR was cut to a record low of two point five per cent. 

In July the Reserve Bank hinted very strongly that the half a per cent cut will need to be reversed pronto as the economy was recovering from the effects of the quake and inflation was looking sprightly.

We all expected a fifty point rate rise in September. Many thought that was the time to start fixing. I did think about it myself, but thanks to inertia, I didn’t do anything about it. At the back of my mind I thought to myself, I’ve heard it all before how interest rates “have” to rise. For a couple of years now circumstances meant rates ignored the “have to” and stayed wonderfully low.

The reason why is simple, “uncertainty”. The international situation remains volatile and since July share markets crashed as worries about the future of the US and Europe become more intense. If you are a pessimist, then there is reason to believe this uncertainty could drag on for months if not years. European and US debt problems are hugely complex and a lasting solution will take time. So there is the prospect that interest rates could stay low for some time.

If you are an optimist, then the Europeans and Americans will come up with solutions and the world economy will start looking a bit perkier. Which, when you think about it is probably the best thing. It would mean the New Zealand economy is likely to do better and that would result in more employment and investment and strong export commodity prices.

If that was the case, the Reserve Bank will definitely start raising rates meaning a switch to fixed mortgage rates would be highly advisable. But it’s all a bit of a “win-win” situation.

If the pessimists prove to be right then a low floating rate will be the wisest course. If the optimists get it right then, sure, interest rates will rise but then most people will feel a lot more secure about their job prospects and their ability to service loans. It would be a good thing if the economy started to race away. You might get caught out a little by rising rates, but they tend to move up in small chunks giving time to switch some money to fixed rates.

What is reassuring is that rates will only go up if the economic outlook starts to look brighter. So sticking with a floating rate would seem the best policy. And even if you are proved to be “wrong”, then you can enjoy the fact that the New Zealand economy is starting to look a lot healthier.