Reserve Bank warns of higher borrowing costs

The Acting Governor of the Reserve Bank, Grant Spencer, has warned households to prepare themselves for higher interest rates in the future.

"[Borrowers and banks] have to be careful to make sure that debt servicing capacity is there at not just today's rates, but rates that are a bit higher," Spencer said at a press conference following the bank's release of its quarterly monetary policy statement where it held the Official Cash Rate at 1.75 percent.

When asked whether New Zealanders should be preparing for higher rates, Spencer replied that they should be.

"If you are borrowing you should be thinking if you can afford that mortgage at two percent higher than you are paying upfront. I'm not saying that two percent is where rates are going, but that's a typical buffer."

Spencer was discussing the effects on households of a possible increase in bond yields internationally, given New Zealand's banks source some of their financing overseas. An increase in international bond yields would push up the cost of funds for banks who would that cost to their borrowers.

Recent increases in the debt-to-income ratio has shown that households have seized the opportunity afforded by low interest rates to borrow cheaply. Spencer noted optimistically that New Zealand's debt-to-income ratio had dropped back recently, meaning households were more prepared.

"We've got to a point where debt to income ratios are no longer increasing because credit growth has slowed … that's a positive sign," he said.

"Where we get really concerned is when debt ratios are going north as well as having this risk of higher interest rates."

The banks own projections suggest it doesn't think higher borrowing costs are on the horizon. It held the Official Cash Rate at 1.75 percent and projected holding that steady until 2020 when it would rise (barely) to 1.9 percent. By 2021 it would sneak up further to 2.2 percent. This suggests the bank expects to see some inflation the future, but it's hardly the 8.25 percent rate the bank set between July 2007 and June 2008 as the bank tried to cool inflation, which pushed mortgage rates up towards 11 percent.

Most banks now offer fixed mortgage rates from between 4.4 percent to 5.4 percent.

Spencer was cautious to not predict a certain level for mortgage rates or that they would rise by a definite amount. His predecessor Graeme Wheeler warned in an unusual Op-Ed in the New Zealand Herald in October 2013 that: "We currently expect that the official cash rate could increase by two percent from 2014 to the beginning of 2016. This could result in interest rates on first mortgages of seven-eight percent."

He put up the Official Cash Rate by 100 basis to 3.5 percent in mid 2014, but had to lower it by the same amount the next year after the forecast inflation did not arrive. He subsequently had to cut rates even further to 1.75 percent through 2016.