The RBA is set to raise interest rates again on Tuesday – and for months to come – prompting warnings Australian families will be ‘devastated’ by the cost.
All eyes are on the Reserve Bank of Australia (RBA), which will deliver its June interest rate decision tomorrow.
Economists universally urge the RBA to raise the official exchange rate (OCR) again from its current level of 0.35%; although opinions are divided on whether he will go for a traditional 0.25% hike or a steeper one.
The RBA is also expected to aggressively raise interest rates over the coming year. The median forecast from economists is for the OCR to peak at around 2.5%, matching RBA Governor Phil Lowe’s statement in May in which he said he planned to raise the target cash rate to at least 2.5%.
The futures market is even more hawkish, the RBA swing will take the OCR to around 3.5% by May 2023.
Expected interest rate hikes would devastate household finances
Assuming economists’ or market’s OCR forecasts are fully passed on to mortgage holders, the average variable discount mortgage rate would drop from its current level of 3.7% to between 5.85% and 6.85% d by mid-2023.
This would represent the largest proportional increase in mortgage rates in Australian history and would devastate household finances, the housing market and the Australian economy.
To illustrate why, consider the following table showing the average monthly repayment on median priced housing across Australia, assuming a 30-year variable rate mortgage and a 20% deposit:
If the economists’ forecast materializes and the OCR rises another 2.15% (to 2.5%), the average monthly mortgage payment on the Australian home at the median price would increase by $781, or 28%. The impact would be greatest in Sydney, where monthly mortgage repayments would rise by $1,163.
If the futures market forecast comes true and the OCR rises another 3.15% (to 3.5%), then the average monthly mortgage repayment on the Australian home at the median price would skyrocket by 1174 $ (42%), with refunds in Sydney. of $1748 per month.
The impact would be even more severe for borrowers who took out a fixed rate mortgage at the height of the pandemic at floor rates below 2.5%.
According to the economists’ OCR forecast, these fixed-rate borrowers would face more than a doubling of mortgage rates when they refinance in 2023 and 2024, while mortgage rates would triple according to the market’s OCR forecast.
With around $500 billion in fixed rate mortgages set to expire by the end of 2023, hordes of Australian households are facing a devastating mortgage reset shock.
The economy could fall into recession
Household consumption is driving the Australian economy greatest driver, accounting for about 55 percent of growth on average. Thus, if mortgage payments rise too steeply, it will mean that there will be less funds available for spending across the economy, which will crush economic growth.
The negative drag on household consumption would be exacerbated by a sharp fall in property prices, which would impoverish Australians.
Falling mortgage rates to record lows during the pandemic has been the main driver of the generational boom in house prices in Australia. A spike in interest rates would have the opposite effect by causing a major correction in real estate prices.
In its latest Financial Stability Review, the RBA estimated “that a 200 basis point rise in interest rates from current levels would lower real house prices by around 15% over a two-month period. year “.
As a result, economists’ forecasts of 2.5% OCR suggest a peak-to-trough fall in Australian real house prices of more than 15%, with nominal values down more than 20%.
The futures market’s 3.5% OCR, however, would “crush” the housing market, with real house prices falling by around 25% in real terms and more than 30% in nominal terms, the modeling suggests. of the RBA.
Aggressive interest rate hikes won’t stop inflation
Australian inflationary pressures are mainly imported, notably via oil and material prices.
The broadest indicator of domestic inflation – wages – remains weak, despite the tight labor market. The March quarter wage price index showed annual growth of only 2.35%, while the national accounts for the first quarter of last week showed only 2.2% growth in the average compensation per employee.
Most telling is Australia’s Real Unit Labor Cost (ULC), which, according to the Australian Bureau of Statistics, “is an indicator of the average cost of labor per unit of output produced in the economy” and “is a measure of the costs associated with the employment of labor, adjusted for labor productivity”. They collapsed 6.3% below their pre-pandemic level and fell for almost 35 years.
Clearly, the RBA does not face a price-wage spiral like those seen in some other jurisdictions and does not need to fight wage growth by aggressively raising the OCR. On the contrary, wages in Australia are disinflationary given the decline in ULC.
As such, there is no justification for the RBA to aggressively hike rates to counter imported (cost-push) inflation. Such a strategy would exacerbate the cost of living pressure for households and hammer the economy without relieving the very forces that are fueling the inflation problem in the first place.
Government should help RBA fight inflation
The main risk for Australian inflation is an energy crisis also imported by war profiteering gas and coal companies.
The only lasting solution to this is for the Australian government to set aside enough domestic volumes of gas and coal to drive down local prices. With packages if needed.
Energy is only 3% of the CPI, but it is already on the way to doubling, and since it is a cost for all other businesses, all costs will increase, as well as prices for users. final.
If nothing is done to address the energy crisis, the RBA could be forced to raise interest rates higher than the broader economy can do to make way for an oil price shock. empty energy.
It would be needlessly destructive to Australia’s standard of living.
Leith van Onselen is Chief Economist at MB Fund and MB Super. Leith previously worked at Australian Treasury, Victorian Treasury and Goldman Sachs.
David Llewellyn-Smith is chief strategist at MB Fund and MB Super. David is the founding publisher and managing editor of MacroBusiness and was the founding publisher and global economics editor of The Diplomat, Asia-Pacific’s leading geopolitical and economic portal. He is co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review. MB Fund is underweight Australian iron ore miners.