What Does a Lower OCR Mean for Kiwi Mortgage Borrowers?

In this story we cover:

• What does a lower OCR mean for Kiwis with mortgages?
• What does a lower OCR mean for the NZ economy?
• What do falling interest rates mean for the housing market?

In welcome news for Kiwi borrowers, the Reserve Bank (RBNZ) has recently cut the Official Cash Rate (OCR) by 0.25%, marking the start of what will be a gradual easing of interest rates over the coming months.

The decision has come in response to the extensive weak economic data we’ve seen of late (particularly in the last month or two) from all parts of the New Zealand economy.

The RBNZ has also acknowledged the fact that inflation has tracked well below its own forecasts over the last three quarters. Although the official numbers don’t reflect it quite yet, annual inflation is expected to be comfortably back within the target range of 1%-3% by October.

With the unemployment rate also tracking upwards (having hit 4.6% in the June 2024 quarter) the RBNZ saw enough to know that high interest rates had done the job.

According to the RBNZ’s updated forecasts, we can expect to see two further OCR reductions by Christmas (totalling 0.5%), and an additional 1% reduction in rates to be delivered incrementally over the course of 2025.

Given how adamant the RBNZ had been that high interest rates were here to stay until the end of next year, and up until very recently too, that’s a pretty remarkable, and very welcome, turnaround.

A “neutral” OCR, which neither stimulates nor suppresses the economy, is 3%. Ultimately, that means we can expect interest rates to settle somewhere around 4.5%-5%, although they could temporarily drop below that if necessary to kick-start the economy again.

What does a lower OCR mean for Kiwis with mortgages?

So, interest rates are officially on the way down again. What does that mean for Kiwi mortgage borrowers? The biggest and most immediate benefit is probably going to be psychological.

Between the struggle to meet higher mortgage costs, and the RBNZ’s insistence that there would be no relief on the horizon until 2025, borrowers haven’t had much cause for optimism over the last couple of years.

Now, there’s finally some light at the end of the tunnel, so people will be starting to feel a lot less doom and gloom about what the future holds.

Then, of course, as lower interest rates start to trickle through to borrowers over the next six to 12 months, that’s going to bring some much needed financial relief as well.

If, for example, you’ve got a $600,000 mortgage, on a 25-year term, and you’re paying principal and interest, a 1% reduction in interest rates (from 6.95% to 5.95%) is going to translate to an extra $374 back in your pocket every month.

For property investors, or anyone else on interest-only terms, it’ll be slightly more, closer to $500.

So, the numbers aren’t huge, but every dollar helps.

What does a lower OCR mean for the NZ economy?

In the short term, at least, a lower OCR won’t have much of an effect on the wider economy. When interest rate hikes first started to bite, you might remember it took longer than expected for that to have any real flow-on effect in terms of our economy.

That’s because, at that stage, a lot of people had savings they could tap into to help cover higher mortgage costs, so it meant they didn’t really need to cut back on their spending.

But over the last couple of years, all those savings have been eaten up, and people have been forced to dramatically change their spending habits, which is a big part of the reason we’ve seen such a huge drop-off in economic activity over the last quarter or two.

Now, the flip side of the equation is that, while interest rates are finally on the way down again, it’s going to take a while for people to financially recover from the last couple of years.

Again, if you think about that example I mentioned earlier, an extra $374 in your pocket every month is something, sure, but it’s not a lot. Realistically, most of that is probably going to go towards necessities. Beyond that, if there’s anything left over the priority for most will probably be rebuilding those savings.

Global forces will affect our recovery

Global forces are also going to have an impact on our recovery. Countries all over the world have been waging their own economic battles over the past couple of years and, for many, the fight isn’t over.

We were among the first countries to go into recession, and others are yet to follow.

China’s economy, in particular, is having real problems, verging on deflationary territory. Chinese consumers have closed their wallets in a big way. And as China is New Zealand’s largest export partner, that’s going to have implications for us here.

We’ve also seen mixed economic signals starting to come out of the US. They’ve managed to dodge recession so far, but their unemployment rate is tracking upwards, so there’s a bit of a question mark over whether their luck will continue.

NZ’s economy: a slow but steady recovery

All of these points indicate a relatively slow recovery for New Zealand. Between the weak economic situation here, and the likelihood that global growth is probably going to be relatively flat over the near future, we’re not out of the woods yet.

It’s going to be a slow and steady recovery, probably with some added speed bumps thrown in along the way as a result of what’s playing out overseas.

At a local level, we’ll need to see a recovery in business and consumer confidence. We need to see companies start to think about investing in the future again before we see any meaningful upside.

Over the coming months, I’m predicting a gradual improvement in some of the underlying economic metrics, such as confidence levels and maybe a bit more stability in the housing market, but nothing dramatic.

What do falling interest rates mean for the housing market?

Things have been pretty weak in the housing market over the past few months. We’ve had a flood of new listings come to market since the start of the year, and although there have been some buyers out there, many have held off waiting for some good news on the interest-rate front.

This lack of demand, coupled with oversupply, has seen house prices fall. Now that rates are on the way down again, that should help to stabilise house prices again, and to underpin the market a little as improved affordability starts to draw back buyers.

The big turning point in terms of affordability will be when the banks move to drop their test rates i.e. the rates they use to test borrower serviceability. Right now, test rates are still sitting up around 9%, but (particularly with the introduction of new DTI rules) that’s feeling increasingly out of touch with reality.

Once test rates do start to come down again, likely within the next 3-6 months, buyers will have the flexibility to borrow a little bit more, which will potentially be the boost they need to get into the sort of property they really love. So, that is what’s going to really help draw buyers back into the market again.

In my eyes, the market’s not about to take off again by any means, but the foundations are there for a partial recovery in house prices over the course of next year.

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John Bolton founded Squirrel in 2008. He is a former General Manager at ANZ, where he was responsible for the bank’s $60bn of retail lending and deposits. He has 10 years of senior banking experience behind him in financial markets, treasury, finance, and strategy, and is a director of Financial Advice New Zealand, the industry body for financial advisers. Check out Squirrel’s website for how Squirrel helps first home buyers, here.