Why are interest rates rising?

How do banks set interest rates?

Interest rates (including rates for home loans, business loans, savings accounts, and term deposits) are determined by a number of factors.

The money banks lend to customers comes from a variety of sources, including our own customers who deposit savings with us. Anyone with a savings account or term deposit is essentially lending us their money and the bank generally pays interest in return.

We also borrow from other commercial banks and large financial institutions around the world. These financial institutions charge each other ‘wholesale’ interest rates to borrow what are generally very large amounts of money.

Banks then lend that money to their customers at a higher interest rate than they borrowed it. That is why the interest rates paid on savings accounts are lower than the rates charged for home loans.

When the cost of borrowing — whether from domestic customers or internationally — goes up or down that impacts term deposit rates and home loan rates.

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How do those interest rates relate to the Official Cash Rate?

The Official Cash Rate (OCR) is set by the Reserve Bank of New Zealand and is reviewed seven times a year.

Broadly speaking, the OCR is the price commercial banks, like ANZ, pay to borrow money overnight. Where the OCR is now, and where markets expect it to go in future, in turn, influences longer term interest rates.

The OCR generally has a more direct impact on floating rates. But fixed term rates are more influenced by financial market expectations of where the OCR is heading over time. This is especially the case for shorter-term rates out to around 2 years.

Beyond about the 3-year mark, global factors become more important in determining the level of interest rates.

This is why fixed mortgage rates don’t always move at the same time as the OCR — market expectations change every day.  The OCR is only one factor that determines bank lending rates, but it’s a very important one.

And while the OCR and floating mortgage rates typically move very closely together, it’s often changing expectations about future OCR decisions that cause fixed mortgage rates to go up or down.

Why has the Reserve Bank been increasing the Official Cash Rate recently?

The Reserve Bank uses the OCR as a tool to help achieve its goal of maintaining economic stability (including controlling the rate of inflation domestically).

The Reserve Bank wants the economy to grow, but not too quickly. The growth needs to be sustainable.

A higher OCR will generally curb demand and a lower OCR will generally stimulate demand.

If the economy slows, the Reserve Bank can cut rates to make it cheaper to borrow, encouraging people to spend and businesses to expand.

But if the economy looks like it may be overheating, the Reserve Bank will hike rates to slow things down, by encouraging people to save rather than spend.

Over the past year inflation has increased rapidly, prompting the Reserve Bank to hike the OCR.

People need to consider their own financial wellbeing, including what’s important to them, and how comfortably they can meet their current and future financial commitments.

Why is the Reserve Bank so worried about inflation?

The RBNZ is tasked with keeping inflation at an annual rate of between 1 and 3%; but in the year to June 2022 it reached a 32-year high of 7.9%.

A rapid increase in inflation hurts people’s spending power and devalues their savings. This can leave both consumers and businesses feeling less certain about the future.

If goods and services cost more, consumers will tend to keep spending money on things they absolutely need (like food, fuel, and utilities) and cut back on things they don’t consider essential.

That can start to harm segments of the economy, undermining investment confidence and leading to businesses closing and job losses.

So the Reserve Bank began lifting the Official Cash Rate in October 2021 to try to dampen inflation and cool the economy.

How high might the OCR rise?

ANZ’s economists are forecasting the OCR will peak at 4.75% in 2023 (up from a previous forecast of a peak of 4%).

One of the key drivers of their view is that the job market remains extremely tight and strong wage growth is partially offsetting the impact of higher interest rates.

They are forecasting that economic growth will slow, but believe the RBNZ will need to keep lifting the OCR to offset the high inflation rate.

What does this mean for people with a home loan?

The combination of rising inflation and increased interest rates means higher costs for borrowers.

ANZ’s economists forecast the OCR and other interest rates, but not even the best forecasters get it right all the time. Surprises like the Ukraine war and the surge in petrol prices happen, and they can dramatically change the outlook.

As such, borrowers need to keep an open mind about where mortgage rates might go.

We would encourage any customers who have concerns, or who want to take the opportunity to talk about their finances, to contact the bank. People shouldn’t be nervous about the idea of talking to their bank.

We have various options available to support customers.

There is also a range of information available online to help people with their finances.

What do I need to think about when deciding whether to fix or float?

People need to consider their own financial wellbeing, including what’s important to them, and how comfortably they can meet their current and future financial commitments.

Most borrowers with home loans can choose fixed or floating interest rates on their loan, or have a mix of both.

Choosing a fixed interest rate means you lock in an interest rate, for a set amount of time.

During that time, your repayment amount stays the same. While you have certainty of repayments for a time, there may also be restrictions or fees that apply when making extra, or lump sum repayments to your loan.

Choosing a floating interest rate means your interest rate is not locked in, so it goes up or down in line with market changes, as do your repayment amounts.

While your repayments may move up and down, there may also be more flexibility to make extra repayments to your loan.

Most lenders offer the flexibility to split the loan into a mix of fixed and floating interest rates, or even a mix of different fixed rate periods to suit your circumstances.

The decision on whether to fix or not often comes down to the value someone places on having flexibility, versus having certainty about their repayments.

Talk to us for financial advice about your home loan options, and see our advice statement.

What about savers?

The rise in rates may boost returns for people who are saving, such as retirees and people saving for a first home.

Like borrowers, savers can choose a savings account, term deposit, or other investment that meets their needs.

They might consider how much they have to invest or want to save, when or how they might need to access the money, and how much they want as a return and level of risk they’re prepared to accept as a result.

For example, some people have more than one savings account, or term deposit. One account might be for emergencies, another for ‘treats’ like a holiday, and another might be for long-term savings goals.

Over time, however, inflation may reduce the value of savings, particularly where the inflation rate is higher than the interest earned. What that really means is that the money in your savings might not go as far as it previously did when you go to spend that money on something.

So, people need to think about whether they want to put money in a savings account, a term deposit, or some other form of investment.

Talk to us for financial advice about your savings and investment options, and see our advice statement.

This material is for information only and is not intended as financial advice. We recommend seeking financial advice before acquiring any financial product. Talk to us for financial advice and see our advice statement at anz.co.nz/fapdisclosure. To the extent the law allows, ANZ Bank New Zealand Limited does not accept any responsibility or liability arising from your use of this information. Investment performance is not guaranteed and may be negative or positive.