Interest rates just hit a fresh low. Could we see a rate starting with 3 in by the new year?

Independent economist Cameron Bagrie says it’s no surprise the competition is heating up in the banking sector.

“The housing market's doing nothing at the moment, he says, explaining that new house sales are not doing enough to deliver customer growth for the banks.

“When you're not getting the volume growth, you tend to go a little bit more aggressive in regard to pricing."

Mortgage holders could be forgiven for wondering why banks are dropping fixed rates now when the Reserve Bank reduced the official cash rate to 2.5% in early October.

Infometrics chief forecaster Gareth Kiernan explains that floating rates tend to pass through to mortgage holders as soon as the OCR drops.

“What we've seen over the longer term is around about an 80% pass-through [to customers] in terms of cuts or raises going in either direction,” says Kiernan.

With fixed rates, the issue becomes a bit more complicated because it requires the banks to forecast what rates might do in the future.

The challenge for the banks is giving customers enough of an incentive to go through the rigmarole of switching – something which is far easier said than done.

Why are rates dropping now?

Mortgage holders could be forgiven for wondering why banks are dropping fixed rates now when the Reserve Bank reduced the official cash rate to 2.5% in early October.

Infometrics chief forecaster Gareth Kiernan explains that floating rates tend to pass through to mortgage holders as soon as the OCR drops.

“What we've seen over the longer term is around about an 80% pass-through [to customers] in terms of cuts or raises going in either direction,” says Kiernan.

Infometrics chief forecaster Gareth Kiernan. Photo: Chris McKeen

With fixed rates, the issue becomes a bit more complicated because it requires the banks to forecast what rates might do in the future.

“In terms of the fixed rates, it often depends on how financial markets are pricing things in and what they're picking for future Reserve Bank moves,” says Kiernan.

This means fixed deposit rates will often come down in advance of an OCR announcement if the banks expect the Reserve Bank to make a cut.

Where this becomes tricky is if the Reserve Bank goes harder (or softer) than the banks expected.

The surprise element definitely played a role in the previous OCR decision, with bank forecasters divided on how much lower the OCR would go.

“With the 50 basis points cut in October, the markets weren't fully priced in,” says Kiernan, explaining it led to banks dropping their rates further after the fact.

Now that the lower OCR has been fully priced in, attention turns to the future and what the Reserve Bank is likely to do at the next OCR announcement in November.

This means fixed deposit rates will often come down in advance of an OCR announcement if the banks expect the Reserve Bank to make a cut.

Where this becomes tricky is if the Reserve Bank goes harder (or softer) than the banks expected.

The surprise element definitely played a role in the previous OCR decision, with bank forecasters divided on how much lower the OCR would go.

“With the 50 basis points cut in October, the markets weren't fully priced in,” says Kiernan, explaining it led to banks dropping their rates further after the fact.

Now that the lower OCR has been fully priced in, attention turns to the future and what the Reserve Bank is likely to do at the next OCR announcement in November.

Lock now, or wait for lower rates?

ASB chief economist Nick Tuffley has forecast one more rate cut before the end of year, bringing the OCR down to 2.25%.

“Beyond then it will be up to the extent to which green shoots become more evident through into early 2026,” Tuffley said in his economic report in mid October.

Both Bagrie and Kiernan are in the same camp, suggesting that we seem to be nearing the trough in this cycle.

One thing to watch during the November OCR announcement is whether we get any messages from the Reserve Bank on where they see the bottom.

“If they were to signal that 2.25% is not the bottom and maybe 2% is the bottom, then we will probably see renewed downward pressure on those fixed rates again as markets adjust to that,” says Kiernan.

What this means is that the November announcement from the Reserve Bank should be followed closely, not in regard to whether a cut will happen (that’s already been priced in), but rather for the messaging we might get from the Governor.

If the Governor does send a strong signal that we can expect another cut in the new year, then it might be worth waiting for the impact of that to feed through to fixed interest rates.

There’s a small glimmer of hope emerging that we may see interest rate that starts with a 3 before the end of the year, but this still looks a little too optimistic when cast against the forecasts.

Bagrie tells me: “I can’t give anyone advice, but I’m currently in the position of looking at my residential property and have few five-year terms rolling off. I’m hoping to nab a three-year term at around the 4.5% mark.”

Everyone will have to weigh up their own pros and cons, and there likely will be some lower, shorter-term rates, but we are still some distance off a 3.

Remember, TSB is essentially going first by pricing in November’s OCR cut now and it made headlines for cutting its rate by only 10 basis points.

To bring us into that magic three zone, it would require one of the banks to decrease their lowest rate by at least 40 basis points – which seems a long call before the end of the year.

For something like that to happen, we need to hear a clear signal from the Reserve Bank Governor come November that they were ready to pull the lever again in the new year – and even then it would still be a stretch.

To put this into context, when the Reserve Bank surprised some bank economists by dropping the OCR by 50 basis points, we only saw around 16 basis points wiped off fixed two-year terms.

The one-year rate is always the most vulnerable to the OCR because it reflects where the banks expect the OCR to go in the next 12 months. If the Reserve Bank does give a strong signal that we will see another cut in the new year, it is plausible that some banks might drop their rates closer to the 4 per cent mark – presenting the opportunity for a competitor to headline a promotional 3.99% one-year rate.

But given the forecasts from economists and the green economic shoots we’re starting to see, homeowners may need to wait a bit longer than Christmas to be given a present that large.