What the latest OCR hike means for property

New Zealand homeowners hoping the era of rising interest rates was a thing of the past have been given another reminder that the economic recovery rarely travels in a straight line.

The Reserve Bank has again lifted the Official Cash Rate by 25 basis points to 2.75 percent at its September Monetary Policy Statement, the second consecutive increase and a cumulative 50 basis points of tightening since early July.

The move was widely anticipated, with annual inflation having climbed to 4.1 percent in the June quarter, well above the RBNZ’s one-to-three percent target band. Higher fuel prices associated with conflict in the Middle East have been a significant contributor, although domestic price pressures remain part of the equation.

For independent economist Cameron Bagrie, the decision was largely expected.

“You’ve got headline inflation a little bit higher than what they’d like it to be, driven by oil, but if you look outside of that at core inflation, it’s still two-and-a-half to three percent across most measures.”

“The economy is definitely on a recovery trajectory. It’s not flowing to the housing market yet, but certainly if you look at the export community, there’s economic expansion.”

The RBNZ shared some of that optimism. It says the economic recovery has most likely resumed following lacklustre growth in the June quarter, supported by strong export prices and resilient demand from our trading partners.

However, that recovery remains uneven. Weak income growth, job insecurity and flat house prices continue to constrain household spending and investment, particularly in Auckland and Wellington.

Back towards neutral

At the heart of the latest OCR decision is a concept likely to become increasingly important for borrowers over the coming months: the “neutral” cash rate.

Put simply, neutral is the point at which monetary policy is neither stimulating nor restricting the economy.

Bagrie estimates that rate is now somewhere between three and 3.5 percent, meaning the OCR at 2.75 percent still remains mildly stimulatory.

“They’ve just taken the Official Cash Rate a touch closer to neutral, as opposed to having the foot on the accelerator.”

Which potentially leaves room for further increases.

The RBNZ has explicitly left the door open, saying the OCR “may need to increase further” this year, although it stresses the future path is not predetermined and will depend on incoming inflation and economic data.

Bagrie says financial markets are also expecting another increase before the end of the year.

“If you’re a central bank and you see growth picking up and you’ve got inflation that’s a little bit on the high side, the call is to get back to neutral.”

He notes that neutral itself appears to be moving higher, which could ultimately mean higher average borrowing costs across the economic cycle than New Zealanders became accustomed to during the ultra-low interest rate years.

“The neutral rate looks like it’s rising over time over the last three to four years.

“That’ll mean higher average interest rates across the economic cycle.”

Inflation remains the wildcard

The RBNZ expects inflation to remain above three percent for the remainder of 2026 before returning to its target band by mid-2027 and reaching two percent later next year.

While much attention has focused on higher global oil prices, Bagrie says New Zealand cannot blame its inflation problem entirely to offshore forces.

Domestic, or non-tradable, inflation is running at around 3.5 percent, he says, with costs including council rates and energy charges contributing to persistent price pressure.

“What the Reserve Bank can control is non-tradable inflation, and every way you slice and dice it, non-tradable around 3.5 is not consistent with having your headline inflation rate around one to three percent,” Bagrie says.

“You need to get that number down and then hope that over time the tradable inflation pulse, courtesy of oil prices, subsides.”

Once the OCR reaches neutral territory, however, Bagrie expects the RBNZ will have an opportunity to assess how the economy responds rather than automatically continuing to lift rates.

“Once you get that Official Cash Rate in the neutral zone, then you sit back a little bit.”

“You want to see if core inflation is subsiding. You want to see if the recovery is continuing.

“I’m pretty confident the economic recovery is going to continue. I’m a little bit less confident inflation will subside in 2027 based on what I’m seeing out there.”

What happens to mortgage rates?

For homeowners and prospective buyers, the obvious question is what another OCR increase means for mortgage costs.

The relationship is not always immediate.

Floating mortgage rates tend to respond more directly to changes in the OCR, while fixed mortgage rates are heavily influenced by wholesale markets and expectations about where the OCR will sit in the future.

That means some of the anticipated tightening can be reflected in mortgage pricing before the Reserve Bank makes its announcement.

“A one-year, two-year fixed mortgage rate is really based on an expectation as to where the Official Cash Rate is going to be in the next one to two years,” Bagrie says.

“What markets have got built into their central scenario at the moment is that the Official Cash Rate is expected to move up modestly over the next 12 months.

“We have seen those fixed rates moving up over the past 12 months as not just the actual OCR has shifted up, but expectations as to where the Official Cash Rate is going to be in 12 to 24 months have shifted a little bit higher as well.”

For borrowers, it reinforces the importance of looking beyond individual OCR announcements and considering the wider interest rate outlook when making financing decisions.

Why housing hasn't followed the old script

Historically, lower interest rates have often been a powerful catalyst for housing activity.

This cycle has been different.

Despite substantial monetary easing before rates began moving higher again, the housing market has remained subdued, particularly in Auckland and Wellington.

Bagrie says affordability and the balance between supply and demand help explain why.

While the house price-to-income ratio has improved from its peak as property values declined and incomes increased, he says it remains around twice the level seen at the beginning of the century.

At the same time, housing supply has remained comparatively strong while population growth has softened.

Bagrie estimates underlying demand currently requires roughly 25,000 additional homes annually, allowing for population growth, depreciation of the housing stock and other factors. Building consents, meanwhile, are running at around 40,000 annually, although not every consent will translate into a completed home.

“You’ve got a fundamental imbalance there in the market at the moment that does not suggest prices are going to be rocketing up,” he says.

There are regional exceptions.

Bagrie points to stronger performance in parts of Otago and Canterbury, where economic growth has been more resilient and, in Canterbury’s case, housing remains relatively affordable compared with several other major markets.

A new property normal

The result is a property market increasingly driven by local economic conditions, affordability and population growth rather than interest rates alone.

Bagrie says New Zealand may also be adjusting to a more sustainable long-term relationship between house prices and household incomes.

For decades, property owners in many regions became accustomed to house price growth of five to seven percent a year while incomes increased at a considerably slower pace.

“What we are transitioning towards now is, I think, a more sustainable and a better property market. But of course, transitions tend to be tough,” Bagrie says.

“The long-term outlook for property is probably going to anchor to growth in incomes.”

Rather than requiring another substantial fall in house prices, he says the adjustment could occur through a prolonged period in which values move sideways or rise more slowly than household incomes.

For buyers and sellers, that suggests patience may remain a defining feature of the market.

The economic recovery is underway, and the latest GDP data has since shown the economy expanded 0.2 percent in the June quarter, ahead of forecasts, while annual growth reached 2.6 percent.

But with inflation still elevated, interest rates nudging higher and housing supply outstripping underlying demand in parts of the country, the traditional recipe for a rapid property upswing is not yet in place.

Instead, the next phase of the market looks likely to be more measured, more regional and increasingly connected to the fundamentals that underpin sustainable property growth: employment, incomes, affordability and population.

As Bagrie puts it, the transition may be uncomfortable, but the market that emerges on the other side could ultimately be on firmer foundations.