Homeowners should prepare for rising mortgage rates sooner rather than later as the Reserve Bank takes a more hawkish tone on inflation.
In what one economist described as an “astonishing” week for the RBA, the central bank ditched its message of patience on rates and admitted in Senate estimates that its view on inflation now had exchange.
The big four banks now expect the RBA to start raising rates in June, with forecasts that they could reach 1.25% in 2022.
This would be the first rate hike in more than 11 years, with the current cash rate standing at an all-time high of 0.1%.
Such hikes could create serious fiscal hardship for homeowners, with $509 added to the monthly repayments of a $500,000 mortgage if rates rise to 2% by June 2023, according to RateCity.
House prices could also fall dramatically, with the Reserve Bank saying on Friday that real prices could plunge 15% if rates hit 2%.
In its latest financial stability review, the RBA said rising rates would make it harder for households to repay their loans because debt is so high relative to Australian household and business incomes.
“While banks have generally maintained strict lending standards, a large proportion of new housing loans have been underwritten with high debt-to-equity ratios,” the RBA said in its latest half-yearly report on Friday.
RBA’s ‘amazing’ turnaround
Sean Langcake, senior economist at BIS Oxford Economics, said it had been an “astonishing” week for the central bank, with a significant shift in its language regarding impending rate hikes and the outlook for inflation.
Former RBA Governor Philip Lowe, while conceding a rate hike in 2022 was ‘plausible’, had repeatedly stressed that the bank would be ‘patient’ and wait for wage growth to resume before tightening metrics .
But on Tuesday the RBA changed its tune, dropping any mention of patience and instead saying the board will monitor upcoming inflation and wage data as it sets policy to hit target inflation. and full employment.
Mr Langcake said this was nothing new for the RBA, but noted that the change in language was still important amid rising inflationary pressures.
“I saw them having the luxury of waiting for wage growth to show up, and in their messages they were telling us they always did,” he said.
“But the degree has changed, they’ll be ready to move [rates] on much less evidence [of wages growth] now.”
RBA Deputy Governor Michele Bullock said so during an appearance before the Senate Estimates this week, conceding that the RBA’s view on rates and inflation has changed.
“I don’t think anyone at the start of the pandemic would have predicted that we would now be in a position in the world where inflation was rising so dramatically,” she said.
“The best thing to do in these circumstances is to look at the evidence and if the evidence tells you something else is going on, you change your mind – and that’s what we did.”
Indeed, APAC economist Callam Pickering agreed with Langcake that the RBA has changed its tone on rates and inflation over the past week.
He said the RBA is now likely to be less tolerant of inflation levels above its 2-3% target (underlying inflation is currently 2.3%).
“Things have moved much faster than the RBA expected,” he said.
“Every central bank has its limits, a level of inflation that it is not prepared to tolerate, and I think the RBA expects it to hit that limit soon.”
Rate hikes will penalize households
Attention now turns to how high rates will rise and how quickly.
Mr Pickering said the RBA would likely be cautious on rate hikes, forecasting a 0.75% hike this year (3 hikes of 0.25%).
If the central bank is too aggressive, it could trigger sharp declines in house prices and serious cost of living problems for mortgage holders, he warned.
“It’s a very difficult balancing act for the RBA at the moment,” Pickering said.
Mr Langcake expects the RBA to start increasing in June, but agreed increases will be conservative to avoid too big a shock to the economy.
The RBA itself acknowledged on Friday that higher rates would be painful.
In its semi-annual review of financial stability, it said higher inflation will put pressure on household incomes, making it more difficult to make repayments which will also increase due to higher interest rates.
“Loan performance could then deteriorate significantly,” he said.
“The current stress among highly indebted property developers in China highlights these risks.”