It’s no secret that the Official Cash Rate will drop again at the end of the month, but exactly how much the Reserve Bank chooses to cut it by, is still up in the air. There was some suggestion that it could go as far as slicing the OCR by 75 basis points but Kiwibank Senior Economist Mary Jo Vergara says that prediction has been pulled back following the release of the most recent unemployment figures.

“Before the release of those figures there was about a 30 percent chance of a 75 basis point cut, but that’s fallen below that 30 percent.”

The numbers showed unemployment had risen from 4.6% last quarter, to 4.8% in the September quarter.

“It showed that the labour market is softening, but not as fast as you need to warrant a super-sized cut.”

“Right now, we're expecting to see a 50 basis point cut in November, partly because it's a double meeting and there's a long time between then and February’s meeting, so they need to front load a lot of that easing.”

HOW LOW COULD RETAIL RATES GO?

Vergara says there’ll inevitably be a drop in retail rates in response to an OCR cut, and the numbers will be good.

“I think we could see interest rates in the low fives or high fours which is great for households and businesses. We're predicting further cuts next year so that trend in interest rates will obviously continue downwards.”

With the large break between OCR announcements in November and February, there’s also a chance the Reserve Bank could come back with another 50 basis point cut next year too.

“What we're expecting from them is to get the cash rate below 4% to deliver a lot of relief.”

“Once it gets to that point it can then take a more incremental approach and go back to the traditional 25 basis point movement.”

With a 25 basis point cut then expected at every meeting after February, Vergara says Kiwibank is picking the OCR to hit 3% in August 2025.

“After that we expect them to hold it for a few meetings, and then, cut again in 25 basis point increments until it reaches 2.5%”

It’s a rate that sits just below the neutral cash rate.

“Because at that time we might actually need a bit of growth, and we might need a bit of inflation.”

“We're so close to the inflation target right now at 2.2% that there’s a risk of undershooting the target, so the Reserve Bank might actually have to add a bit of stimulus into the economy.”

But even at a rate lower than neutral, Vergara says we won’t be seeing the low retail rates we saw during covid.

COULD ANYTHING CHANGE THAT TRAJECTORY?

While internal factors are favourable for continued cuts to the OCR, Vergara says external and international factors could affect that.

“What's complicating the outlook a little bit is the US election. Rates traders are pricing in more inflation from all the tariff policies that Donald Trump is potentially going to put in place, and that's having an impact on our curve as well. The Reserve Bank can’t control that”

“So while we may see interest rates fall into the 4% range, they potentially may not stay there for very long.”

Vergara says those external inflationary pressures could also mean the OCR ends up landing just above neutral territory, instead of entering stimulatory levels.

WHEN WILL WE FEEL THE EFFECT OF DTIs?

Declining mortgage rates are a welcome relief for homeowners, but buyers should be aware of the impact of debt-to-income ratios on how much they can borrow.

In general, owner-occupiers will be able to borrow a maximum of six times their income while investors will be able to borrow a maximum of seven times their income, with some exceptions, such as for new builds.

“I think we’ll start to see this take effect when the housing market starts to take off a little bit more and interest rates continue to come down, as right now it's still tracking very much sideways.”

“DTIs are a significant development in the Reserve Bank macro financial toolkit, but they're not having an immediate impact. That’s because right now, we're lending well below that level, with the housing market at a slow.”

Vergara expects we’ll start to see the effect of DTIs kick in towards the second half of next year as it becomes even cheaper to borrow money.

“If they were in place in 2020 and 2021 we wouldn't have lent out nearly as much back then. So it's really about the next property boom, which probably isn’t going to happen until 2026 or beginning of 2027.”

WHAT WILL THAT MEAN FOR PRICES?

Vergara says with debt-to-income ratios in place, there’s a clear limit on how much the market bubble can expand.

“Next year, we're expecting gains of about 5 - 7% which is a pretty good range.”

“If the Reserve Bank cuts more aggressively then we'd expect to see house price gains at the top end of that range. But if unemployment rises by more than we expect, we may see more subdued gains.”

But any gain won’t come anywhere near the 40% peak during covid.

The Reserve Bank is due to make its next OCR announcement on Wednesday 27 November 2024.