If financial market expectations prove to be true, Australians could face the most aggressive mortgage rate hikes seen over 40 years.
This week, the Reserve Bank raised its official discount rate by 25 basis points for the first time in more than a decade, reaching 5.1% in the March quarter, against the backdrop of the fastest inflation in 21 years.
Underlying inflation, the index most closely monitored by the RBA, reached 3.7%, surpassing the 2% to 3% target range for the first time since 2010.
Therefore, the move to raise rates on Tuesday was not so unexpected … but there was a reaction from the money markets.
The money markets have fully set the price of the price increase on Tuesday. Market expectations from here suggest that interest rates will reach 3% by the end of the year and could reach nearly 4% by 2023.
If that trajectory goes well, mortgage rates will see large and positive adjustments commensurate with them, and repayments will increase at the rate of knots. In fact, this will be the most aggressive tightening cycle in over 40 years.
I don’t expect this to happen.
This would be an extraordinary feat in peacetime, but these are not in peacetime and there is still some financial uncertainty.
Household sentiment is declining as increasing pressure on budgets reduces consumer confidence.
Inflation is still affected by supply chain disruptions, including ongoing blockades in China, container ship distortions, and rising freight rates. Then there are the spillover effects of rising fuel prices, rising food prices, and the floods on the east coast exacerbated by the crisis in Ukraine.
It’s cost-push inflation. In contrast to demand inflation caused by accelerated spending, wage growth boosts aggregate demand and thus creates sustained inflationary pressure.
Instead, households will be constrained by staying in the negative real wage territory.
Why prices don’t rise as high as market prices
The buffer accumulated by households supports the economy, but living expenses rise, real wage growth remains negative, and increased interest payments further weaken household income.
This is all in line with rising fuel prices, rent pressures and rising food prices.
Major banks predict that the official cash rate could reach 1.75% by the end of the year, and in most cases will reach a final interest rate of over 2% at some point in 2023.
For existing mortgage holders, the affordability of homes will worsen in the next 12-18 months, as interest rates will rise and repayments will be higher.
Moreover, more than 1.1 million borrowers have never actually experienced a rise in interest rates.
Consumption accounts for almost two-thirds of GDP, and for many Australians who rent to own a home, their home is their greatest asset. When the value of this asset declines, we can see that the “asset effect” begins, household spending decreases, and the emphasis is on economic growth.
Reserve banks predict wage growth, but that is not guaranteed.Photo: Getty
Wage growth – big If
This dynamics is the lowest unemployment rate since 1974, offset by tight labor markets and promotes some confidence and job security.
How this dynamics works is very important in determining the amount of this tightening cycle, and there is a lot of uncertainty here.
In New Zealand, house prices are rising despite strong wage growth and low unemployment. However, in Australia’s previous tightening cycle, wage growth was strong and the labor market was tight, with house prices not falling in response to rising interest rates.
Accelerated 300 basis point tightening cycles, like current pricing, give little valuable time to measure how reserve banks are responding to rising interest rates.
These factors can influence a more measured approach from the RBA now that the tightening cycle has begun. After all, the RBA is trying to normalize policy from the current stimulating emergency setting, rather than reversing the economy.
The tightening cycle affects real estate prices. Photo: realestate.com.au/sold
The real problem for homes and businesses is where interest rates peak.
There are some hints that the RBA is currently working on a period of rising interest rates. Their expectation is that by mid-2024, inflation will still be at the upper end of the 2% to 3% target range.
But again, the RBA may hesitate to raise interest rates too soon, with fewer people engaged in employment, weaker wage growth and lower overall economic activity. recognizing. This is an undesired result for the RBA and their full employment goal.
That said, the tightening cycle has begun, and households may be able to survive a slower tightening trajectory, aside from aggressive market pricing. The economy is strengthening, the labor market is tight, and real wage growth is currently negative, but we expect the situation to begin to change.
According to the Australian Bureau of Statistics, just under one-third of households own their homes completely, the remaining one-third are renters, and just over one-third are repaying their mortgages. .. Households with these debts have historically been in a strong position after the pandemic due to high savings, soaring asset prices and a strong labor market.
Mortgage debt is rising and income is growing slowly, but home prices are rising rapidly and historically low interest rates allow many to repay more debt. I did. The cost of paying off that debt (defined as the percentage of household disposable income towards debt repayment) has declined over the last three years.
Debt-bearing households are also taking advantage of lower interest rates to pay off their debts faster.
Through the pandemic, households have surplus savings of about $ 240 billion RBA April Financial Stability Review It turns out that typical homeowners are about two years ahead of their mortgages – only one year in 2018. A significant portion of the borrower is also isolated from at least the initial rise in interest rates given about 40% of the borrower’s fixed mortgage rate, which changes at the end of the fixed period.
All mortgages brought out in recent years have been approved based on the fact that the borrower can continue to process the mortgage with an additional buffer of 2.5 percent points. This increased to 3 percentage points in November 2021.
This should mean that most borrowers are good at managing a proper tightening cycle.
However, even if home prices fall, there is considerable buffer given that many existing homeowners have significant home wealth after a significant rise in home prices.
According to the April Financial Stability Review (and as the graph above shows), households near zero are negative equity, and even if home prices fall, their share will only increase very slightly.
Risk can be concentrated on people with relatively new mortgages who have grown themselves in the hope of increasing their income. As their repayments increase, these households can be the victims of financial stress, especially if the living environment turns negative.
Low interest rates are clearly an important factor, making it easier for households to pay off their debts, but all of these factors suggest that most households have some protection from financial stress.
Australia’s tightening cycle the Most aggressive in developed countries
This chart shows the number of rate hikes or cuts suggested by market prices in different economies.
As in June last year, financial markets were unlikely to see multiple cash rates rise in 2022. Currently, the market is pricing that the cash rate will exceed 3.0% and end at the end of the year, with the potential to reach nearly 4.0% the following year.
Things change very rapidly in the market. And it is unlikely that the RBA will be able (or even need to) raise interest rates aggressively.
So what does that all mean for homes?
Record low interest rates, lack of housing stock, and pandemic-fueled hunting by urban dwellers seeking larger homes, gardens, and more rural life have become the perfect storm of the pandemic-induced real estate boom. rice field.
The housing market started this year with a solid foothold, but slowed as the cycle ended. Rising fixed mortgage rates, affordable price constraints, rising real estate for sale, and expectations of faster rate hikes have all significantly rebalanced the housing market since last year.
When the cash rate rises, the borrowing interest rate rises and the borrowing capacity declines.
according to PropTrack Home Price Index Currently, price growth is stagnant nationwide, especially in major capital cities.
Today, the threat of early compressed tightening cycles by the RBA is a further restraint. In addition to the seasonally quiet winter months, activity can continue to slow as households are under pressure and affordable mortgages fall. There is a growing outlook for more widespread price declines.
Here, the scale and timing of rate hikes is important in determining the extent of the loss of momentum in the housing landscape. As currently priced, the compressed aggressive tightening cycle is more negative than the slower and more measured tightening pace that the RBA is expected to undertake.
In the latter scenario, higher borrowing costs are ultimately buffered by stronger wage growth, and the housing market can avoid the significant price declines that some expect.
These headwinds will continue to slow demand from future buyers, but price increases may continue to slow.