The RBA is expected to raise interest rates again tomorrow and in the coming months, warning that Australian families will be “devastated” by the cost.
All eyes are on the Reserve Bank of Australia (RBA), which will rule on its June interest rate decision tomorrow.
Economists are universally tilting the RBA to raise the official cash rate (OCR) again from its current level of 0.35 percent; although opinion is divided on whether to opt for a traditional 0.25 percent rise or a more pronounced increase.
The RBA is also expected to aggressively raise interest rates over the next year. The average forecast for economists is that the OCR will reach a high of about 2.5 percent, which is in line with the statement by RBA Governor Phil Lowe in May, in which he said he hopes to raise target cash rate at least 2.5 percent.
The futures market is even more hawkish, with the RBA leaning to raise the OCR around 3.5 percent in May 2023.
The projected rise in interest rates would devastate household finances
Assuming that OCR forecasts from economists or the market were fully passed on to mortgage holders, the average variable discount rate would increase from its current level of 3.7% to between 5.85% and 6.85% in the middle of 2023.
This would represent the largest proportional increase in mortgage rates in the history of Australia and would devastate the finances of households, the housing market and the Australian economy.
To illustrate why, consider the following table showing the average monthly return on average Australian housing, assuming a 30-year variable interest rate mortgage and a 20 per cent deposit:
If the economists forecast to come to fruition and the OCR increases another 2.15 per cent (up to 2.5 per cent), then the average monthly mortgage return on the average Australian house would increase by $ 781. , or 28 percent. The impact would be greater in Sydney, where monthly mortgage payments would increase by $ 1,163.
If the forecast for the futures market comes true and the OCR increases another 3.15 per cent (up to 3.5 per cent), then the average monthly return on the Australian home mortgage at an average price would increase by $ 1,174 (42 per cent), with refunds across Sydney. for $ 1748 a month.
The impact would be even more severe for borrowers who took out a fixed-rate mortgage during the pandemic’s peak at rates below 2.5 percent.
According to economists’ OCR forecasts, these fixed-rate borrowers would face more than double the mortgage rates when they come to refinance in 2023 and 2024, while mortgage rates would triple below the market OCR forecast.
With some $ 500 billion in fixed-term mortgages maturing by the end of 2023, hordes of Australian households are facing a devastating mortgage reshuffle.
The economy could go into recession
Household consumption is the main driver of the Australian economy, accounting for around 55% of average growth. Therefore, if mortgage payments rise too sharply, this will mean that there will be less funds available for spending across the economy and, in turn, will slow economic growth.
The negative drag on household consumption would be exacerbated by a sharp drop in house prices, which would make Australians feel poorer.
Falling mortgage rates to historic lows during the pandemic were the main driver of the generational rise in house prices in Australia. Rising interest rates would have the opposite effect of providing a significant correction in the price of housing.
In its latest financial stability review, the RBA estimated that “a 200 basis point increase in interest rates from current levels would reduce real home prices by about 15 percent during a period of two years “.
Therefore, economists’ forecast of an OCR of 2.5 per cent suggests a maximum-to-minimum fall in real Australian house prices of more than 15 per cent, with a fall in nominal values by more than 20 per cent. per cent.
OCR 3.5 per cent of the futures market, however, would “crash” the housing market, with real house prices falling by around 25% in real terms and more than 30% in nominal terms, according to the RBA model.
Aggressive interest rate hikes will not stop inflation
Inflationary pressures from Australia are mainly imported, including petrol prices and materials.
The broader indicator of domestic inflation, wages, remains subdued, despite the narrow labor market. The March quarterly wage price index showed annual growth of only 2.35%, while national accounts for the first quarter of last week saw growth of only 2.2% in average compensation for employee.
The most revealing is Australia’s real unit labor cost (ULC), which according to the Australian Bureau of Statistics “is an indicator of the average labor cost per unit of production produced in the economy” and “is a a measure of the costs associated with employment, adjusted for labor productivity. ”They have collapsed 6.3% below their pre-pandemic level and have fallen for most of their 35 years.
It is clear that the RBA is not facing a wage-price spiral like those seen in some other jurisdictions and does not need to fight wage growth by aggressively increasing OCR. On the contrary, wages in Australia are deflationary given the fall of the ULC.
As such, there is little justification for the RBA to raise rates aggressively to offset imported inflation (cost boost). This strategy would aggravate the cost of living pressure for households and affect the economy without relieving the same forces that drive the problem of inflation in the first place.
The government should help the RBA fight inflation
The main risk to Australian inflation is an energy crisis that is also being imported by for-profit coal and gas companies.
The only lasting solution to this is for the Australian government to set aside enough domestic volumes of gas and coal to bring down local prices. With fixed prices if necessary.
Energy is only 3 percent of the CPI, but it is already on the verge of doubling, and since it is a cost to any other business, all costs will rise and end-user prices as well.
If nothing is done to rectify the energy crisis, the RBA may be forced to raise interest rates higher than the economy as a whole can bear to make way for an empty energy price shock.
This would be unnecessarily destructive to Australian living standards.
David Llewellyn-Smith is chief strategist of MB Fund and MB Super. David is the founding editor and editor of MacroBusiness and was the founding editor and editor of global economics at The Diplomat, the leading economics and geopolitics portal in Asia Pacific. He co-authored the 2008 Great Crash with Ross Garnaut and was the editor of Garnaut’s second climate change review. MB Fund is underweight in Australian iron ore miners.
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