Home loan borrowers worrying about higher interest rates may finally be getting the news they have been waiting for – financial markets now expect interest rates to drop more quickly than previously expected.

Markets are now pricing in about three interest rate cuts from the middle of next year.

Infometrics chief forecaster Gareth Kiernan says it reflects another “turn in sentiment” over the past few weeks about how persistent inflation is likely to be.

“Markets seem to have swung towards global inflation easing more quickly than had been feared, given trends in wholesale interest rates between May and October.”

Chris Tennent-Brown, senior economist at ASB, says long-term bond yields and swap rates have come down “quite a long way” over the past month.

“Expectations that the Reserve Bank could hike again have also been pared back too. It’s a similar story offshore – with international markets more convinced that central banks’ policy rates are peaking.

“Based on our Reserve Bank outlook, and what’s been going on, it seems some of the upside risks to the mortgage outlook have reduced over recent months. But we’ll wait until after the Reserve Bank next week before updating our interest rate forecasts.”

The Reserve Bank will next week update the official cash rate and release a monetary policy statement which will include an indication of where it thinks the rate is likely to go.

Locally, ANZ last week changed its forecast for another official cash rate increase and says it expects the rate to remain on hold at 5.5 per cent until the Reserve Bank os comfortable to cut.

Westpac remains the only main bank still expecting another hike to be needed, although its forecast will be updated this week and could change.

Kiwibank chief economist Jarrod Kerr says the market has fully priced two 25bp OCR cuts next year and is “thinking hard” about a third.

“I agree with the pricing. But the Reserve Bank will be wary. They haven’t tamed the inflation beast, yet. I think they’ll want to keep us on guard until their next MPS in February. I don’t expect much, if any, change to the OCR track.”

Gareth says the change in market expectations is not yet causing problems for the Reserve Bank, because retail home loan rates are still edging higher and doing some additional tightening for the bank. Kiwibank adjusted some of its rates this week.

But Gareth says the bank will need to be careful with its tone next week.

“Any shift in the bank’s forecasts that results in a lower profile for interest rates or an earlier cut than was signalled in the August statement could easily be jumped on by financial markets as an implicit ratification of the recent change in the market’s direction and momentum, and see wholesale rates pushed down further.

“It might not be long before we start to see retail rates easing. The bank would probably be comfortable with that occurring to a small degree, because people are still faced with refixing at higher rates than they have previously been paying, so it’s still acting as a handbrake on the economy. But if one-year or two-year rates dipped back to about 6.6% or below, then that effectively starts to become a loosening in monetary conditions.”

Chris says term deposit rates are still high and have not moved.

-Susan Edmonds/stuff.