Thursday, October 22, 2009

Mortgages to remain cheap?

One of the questions getting a lot of attention is interest rates: when will they start to rise? This is important for a number of reasons:

1. rising interest rates will affect the valuations of equity and debt securities

2. interest rates rising at different times and in different amounts will affect exchange rates

3. rising interest rates will affect the attractiveness of ungeared property as an investment and geared property even more so

4. rising interest rates will increase the cost of funding my floating rate mortgages and adversely impact my cash flow

As recently as last month, a number of experts were talking about 2010Q2 or 2010Q3 for interest rates in the US to start rising with Hong Kong following the US lead because of the currency peg. More recently, expectations of the time for interest rates to rise in the US have been pushed back to the end of 2010. The most cited reason for the delay in raising interest rates is the unemployment situation. Most people would view some inflation as an acceptable price to pay for the creation of jobs. The fact that Australia has already raised interest rates and is now expected to do so again does not seem to have affected the views on US monetary policy.

There is another reason why interest rates may remain low in Hong Kong: supply and demand. Hong Kong continues to remain awash with liquidity. Interest rates were driven to current levels (close to zero on deposits and about 1% on mortgages) because of the amount of liquidity in the banking system. So far this year, total bank deposits have risen by 3.8% while total bank loans have contracted by 2.9%. These numbers are not earth shattering - but they are big enough to appreciably reduce the banks' loan to deposit ratio and to keep the pressure on the banks to hold interest rates at current levels.

Put differently, a market where the supply of money has been materially higher than the demand for money has experienced an increase in supply and a reduction in demand. It is very very hard to see interest rates rising by much in this environment.

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