One particular point made in that article that is relevant right now is that the Variable Housing rate will probably average 8-8½% over the next 5 years.

The Variable rate and the 1-year Fixed rate today are below this average but could well be above average within 12 months. Rates for 2-year to 5-year Fixed Housing loans are already around this average. Seen in this light, the decision to fix is about risk aversion at present rather than achieving a below-average interest rate over the next few years.

To further drive home this point; there is often a disparity between economists' forecasts and actual market events. Financial markets are known for "over-shooting", a term coined to describe those times when interest rates (or share prices or exchange rates) move to extreme levels, be they very high or very low. Meanwhile, economic forecasters are known for "mean-reversion", that is they tend to forecast rates returning towards the average.

Is this such a time? There is a consensus amongst forecasters at present that local interest rates are on a rising trend. Most, however, are merely predicting rates rising to or just above the average levels mentioned above. This could create complacency amongst borrowers. While not predicted, Housing rates above 9% or even 10% are possible (they last occurred in 1998). Individuals need to weigh up what such an event might mean for them and hence approach the fixed interest rate decision as if seeking ! some insurance against high interest rates.

What of rates? What is being priced at present?

In general, current pricing for interest rates reflects a widespread expectation that the Reserve Bank of New Zealand will gradually increase short-term rates over the next 12 months. The RBNZ have been mandated to maintain the inflation rate within a 0-3% p.a. band. While inflation over 2002 was well within this band (1.8%), the inflation rate in the next few months is forecast to increase sharply again. The RBNZ consider current monetary policy to be stimulatory, the result of rate cuts last year, and have indicated that they will raise rates this year to remove this stimulatory bias and hence reduce the risk of persistent high inflation.

Current market pricing assumes that the RBNZ will raise the cash rate target from the current 5% (recently raised from 4.75%) to around 6.0-6.5% by year-end and then to higher levels over 2003.

The two major alternative scenarios are that:

• these rate increases are sharper and quicker than assumed i.e. the current economic pick-up is very strong
  
• the current growth phase peters out quickly and interest rates do not rise to the extent assumed.

With these considerations - the scenarios and the risks - in mind, what are the advantages of various fixed rate terms?

The 1-year fixed rate, even though slightly above the Variable rate at present, will probably be the lowest (or near the lowest) cost in the next 12 months. Two further advantages are (a) there is the opportunity for fee-free early repayment next year and (b) should economic growth slow again, there will be the opportunity for below-average rates. The key disadvantage is that rates are more likely to be higher when the fixed term expires next year.

The 2-year fixed rate has already priced in significant tightening by the RBNZ. However, it does offer security over the time period (the next 1-2 years) when the risk of above-average mortgage rates will be high. Other advantages: should local growth disappoint, rates will be lower when the fixed term comes to expire. Disadvantage: possibility of early repayment fees and relatively high rate (compared to Variable and 1-year) for the next few months.

The 3-year fixed rate shares similar characteristics to the 2-year rate except the rate is higher (disadvantage) but the rate is secure for longer (advantage). At 8.25% (25-Mar), the current 3-year rate is close to the average Variable rate expected over the next 5 years.

The 5-year fixed rate again sees the trade-off extended: a higher rate versus a longer fixed term. While slightly higher than is probably expected as the average Variable rate over the next 5 years, the 5-year rate does have the advantage of surety. Disadvantage: missed opportunity should rates not rise as sharply as assumed and/or rates decline again quickly; and a higher early repayment fee should rates decline.