Fed raises rates for the first time in three years as New Zealand GDP grows 0.2%: should you fix your mortgage for one year or longer?

The US Federal Reserve has raised interest rates for the first time in three years, while New Zealand’s economy avoided contraction in the second quarter with growth of just 0.2%. These two announcements, made on the same day, bring the outlook for interest rates into clearer focus: global funding costs are rising again, while the local economy has yet to weaken enough to force the central bank to change course. For homeowners, the era of ultra-low mortgage rates is over, and higher rates may last longer than previously expected.

On 16 September, US time, the Federal Reserve’s Federal Open Market Committee voted unanimously, 12 to 0, to raise the target range for the federal funds rate by 25 basis points to 3.75%–4%. This was the first US rate increase since 2023.

The Federal Reserve said US economic activity continued to expand at a solid pace, domestic consumption remained resilient, productivity and capital investment were strong, and the labour market was relatively stable, but inflation remained elevated. The latest interest rate projections show that most policymakers believe further increases may still be needed this year. However, the dot plot reflects officials’ assessments of future rates; it does not mean another increase is already certain.

Following the announcement, US shares fell and the US dollar strengthened. The New Zealand dollar fell from around 57.45 US cents to 57.12 US cents, and briefly dropped to around 3.83 against the Chinese yuan.

GDP grows 0.2%, but homeowners may feel little relief

New Zealand’s second-quarter GDP figures were released shortly after the Federal Reserve announced its interest rate decision.

From April to June this year, New Zealand’s economy grew 0.2% from the previous quarter, avoiding the stagnation or contraction some economists had feared. However, growth was markedly slower than the revised 0.9% recorded in the first quarter. The economy grew 2.6% in the year to June.

Construction was a major source of support in the second quarter, with overall activity rising 2.7% and residential construction also recovering somewhat. Accommodation and food services fell 3.8%, while transport, postal and warehousing services fell 1.7%. High fuel costs and living expenses continued to squeeze household spending, and the economic recovery has yet to reach every sector.

These figures are certainly not bad news for New Zealand’s economy, but households waiting for mortgage rates to fall may find little to celebrate. Continued economic growth means the Reserve Bank of New Zealand does not currently need to change policy because of recession risks. Yet growth of 0.2% is also very limited, and insufficient for ordinary households to feel a noticeable improvement in incomes, employment and spending power.

Real GDP per capita remains below its 2023 level. Growth in the overall economy does not mean everyone’s share of its gains is increasing. This also explains why the government sees an economic recovery while many households still feel financially weak.

GDP growth of 0.2% does not mean the Reserve Bank of New Zealand will necessarily keep raising rates, but it reduces the extent to which economic weakness constrains further increases. As long as inflation and oil price pressures do not ease significantly, the central bank still has room to keep interest rates elevated.

Will US rate increases push up New Zealand mortgage rates?

A Federal Reserve rate increase does not automatically trigger a matching rise in New Zealand mortgage rates.

New Zealand’s short-term fixed mortgage rates are mainly influenced by the local Official Cash Rate (OCR), banks’ funding costs, expectations for future interest rates and competition between banks. The Reserve Bank of New Zealand’s assessment of domestic inflation, employment and economic growth remains central to the direction of mortgage rates.

However, US rate increases affect New Zealand indirectly through global bond yields, US dollar funding costs and international capital flows. The money New Zealand banks use to fund mortgages does not all come from local savers’ deposits; some must be raised in overseas wholesale markets. If international funding costs keep rising, New Zealand’s medium- and long-term fixed rates may also come under pressure.

A stronger US dollar and pressure on the New Zealand dollar could also increase the New Zealand dollar prices of oil, equipment and other imports. If these costs flow through to transport, food, building materials and services, controlling inflation will become harder for the Reserve Bank of New Zealand.

The Federal Reserve therefore does not determine New Zealand’s mortgage rates, but it may make the external environment more difficult for the Reserve Bank of New Zealand and local banks.

Mortgage rates have already moved ahead

At present, six-month fixed rates at New Zealand’s major banks are around 4.75%, most one-year rates are below or close to 5%, and most two- to five-year rates range from 5.39% to 5.69%.

Short-term rates have already risen noticeably compared with late last year and early this year. One-year rates have generally moved from the low 4% range towards 5%, while the lower five-year rates available have also risen from around 4.99% to about 5.49%.

The immediate reason is that the Reserve Bank of New Zealand has already re-entered a rate-hiking cycle, with the OCR rising from 2.25% to 2.75%. BNZ chief economist Mike Jones said financial markets had already priced in expectations that the OCR would ultimately reach around 3.5%, and commercial banks’ fixed mortgage rates already reflected some of the risk of further increases.

Jones expects fixed rates may have a further 0.2 to 0.5 percentage points to rise, with pressure concentrated mainly on shorter terms. However, the largest part of the current rise may already have occurred.

Even if the Reserve Bank of New Zealand continues raising rates, banks will not necessarily pass every OCR adjustment through to fixed mortgage rates immediately and in full, because some of the risk is already reflected in current offers.

One-year rates are cheaper, but no longer without risk

One year remains one of the most popular fixed terms. It usually offers the lowest rate, allows borrowers to reassess the market after a year, and makes it easier to repay early, sell a property or switch banks.

Infometrics chief forecaster Gareth Kiernan expects that repeatedly choosing one-year terms over the next few years could produce an average rate of around 5.2%, below current two-year rates of about 5.3% and five-year rates of about 5.7%.

Historical data suggests that repeatedly choosing one-year terms can often lower average interest costs, but this strategy depends on future rates moving broadly in line with forecasts.

The Federal Reserve has re-entered a rate-hiking cycle, while continued positive growth in New Zealand has eased the local central bank’s concerns about recession. If oil prices, import costs and core inflation remain higher than expected, the Reserve Bank of New Zealand may raise the OCR further. Borrowers choosing a one-year fixed rate could then face a higher rate when they refix next year.

A one-year term may still be worth considering for those with sufficient cash flow who can withstand some fluctuations and are willing to compare the market again in a year. But households whose budgets are already tight cannot focus solely on which term is cheapest today.

Pay around 0.5% more for two or three years of stability

At present, the rate gap between one-year and three-year terms is not particularly large.

Westpac chief economist Kelly Eckhold noted that extending a fixed term from one year to three years may cost borrowers only around 0.4 to 0.5 percentage points more. For households worried about further rate increases, that extra interest is effectively insurance for their budgets over the next two or three years.

Opes Partners economist Ed McKnight gave the example of a one-year fixed rate of 4.8% and a two-year rate of 5.2%. Provided the new rate in a year’s time does not significantly exceed around 5.6%, the average cost of two consecutive one-year terms may be no higher than fixing for two years now.

Using its own rates and calculation assumptions, ANZ estimates that the one-year rate would need to rise by around 0.92 percentage points before fixing for one year twice in succession would become more expensive than choosing a two-year term outright.

These two sets of figures use different assumptions and cannot be treated as a single break-even point. However, both show that longer-term rates already incorporate market expectations of future rate increases.

Choosing a two-year term now means accepting a slightly higher rate in return for more stable repayments. Choosing one year amounts to judging that actual future increases will not exceed the market’s current estimates.

How much do monthly repayments differ on a NZ$500,000 mortgage?

Take a NZ$500,000 principal-and-interest loan over 30 years:

At 4.8%, monthly repayments are approximately NZ$2623;
At 5.2%, approximately NZ$2746 a month;
At 5.5%, approximately NZ$2839 a month;
At 6%, approximately NZ$2998 a month.

A rise from 4.8% to 5.2% adds approximately NZ$123 a month; a rise to 5.5% adds approximately NZ$216 a month; and if the rate reaches 6%, monthly repayments increase by approximately NZ$375.

A change of 0.3 to 0.5 percentage points may seem small, but on a loan of several hundred thousand New Zealand dollars, it can still have a noticeable impact on household cash flow. The larger the outstanding balance, the greater the difference.

Homeowners reluctant to commit their entire mortgage to the same term can also consider splitting it. For example, one portion could be fixed for a year to retain flexibility, and another for two or three years, so the whole loan does not reprice at the same time.

Observations and reflections

The Federal Reserve’s return to rate increases shows that the decline in global interest rates will still face reversals, while positive GDP growth in New Zealand indicates that the local economy has not fallen into recession for now. A rapid fall in mortgage rates in the near term is becoming less likely.

New Zealand is not currently experiencing strong growth driven by an overheating economy. GDP is still increasing slowly, but household spending and economic performance per capita have not improved noticeably. Oil prices, import costs and core inflation continue to exert pressure, making it difficult for the Reserve Bank of New Zealand to ease policy readily.

A one-year term may still offer lower costs and greater flexibility, but it can no longer be understood simply as “fix for a year now, and it will naturally be cheaper next year”. If inflation continues to exceed expectations, the rate available when refixing in a year may still be higher.

Two- to three-year terms cost slightly more, but can prevent the entire mortgage from repricing next year. For those with tight household budgets, less stable incomes or little capacity to absorb a sudden increase in monthly repayments, paying around 0.4 to 0.5 percentage points more for certainty may well represent reasonable value.

No one can accurately predict where interest rates will peak. Homeowners should first calculate how much their monthly repayments would increase if rates rose by another 0.5 percentage points, and whether their current income could cover it.

Those who can withstand fluctuations can retain the flexibility of a one-year term. Those who need greater stability can consider fixing for two to three years, or splitting their mortgage across different terms. The priority is to prevent the next interest rate change from disrupting the household budget, rather than to guess the market correctly.