On Tuesday, the Reserve Bank of Australia (RBA) hit mortgage holders another 0.5 percent interest rate increase – the fifth consecutive monthly increase.
The decision sent the Official Cash Rate (OCR) to 2.35 percent, well above April’s record low of 0.1 percent.
once the rate hike is passed on to mortgage holders, the average discount variable mortgage rate will rise to 5.70 percent, from 3.45 percent in April.
Successively, average monthly mortgage payments will soar 30 percent from its pre-April adjustment level:
For a home with a $500,000 mortgage, this represents a monthly increase in payments of $671, while a home with a $1,000,000 mortgage will pay an extra $1,341 per month.
RBA signaled further rate hikes
In the RBA monetary policy statement accompanying Tuesday’s rate hike, Governor Phil Lowe noted that “Inflation in Australia is at its highest since the early 1990s and is expected to rise further in the coming months.” “. Therefore, “the Board expects to increase interest rates further in the coming months, but it is not on a pre-established path.”
Accordingly, the OCR will rise further in the coming months, but how much will depend on incoming data, including the Australian Bureau of Statistics’ national accounts release on Wednesday for the June quarter.
Current forecasts for the OCR vary among economists and the bond market.
CBA, AMP and NAB had forecast OCR to peak at 2.6%, while ANZ and Westpac forecast a peak of 3.25% in early 2023.
The bond market is even more aggressive, with a maximum OCR price of 3.85 percent by mid-2023.
Based on the RBA’s statement that it “expects to raise interest rates further in the coming months”, we should expect the low-end economists’ forecasts to shift to the upside.
The table above illustrates the impact on Australian mortgage holders in three rate increase scenarios:
– Low scenario: Assumes two more OCR increases of 0.25 percent.
– Medium Scenario: Assumes ANZ/Westpac’s 3.25% OCR forecast holds.
– High Scenario: It assumes that OCR’s 3.85 percent bond market forecast comes true.
Under the low scenario, Australia’s average discount variable rate mortgage would rise to 6.20 per cent.
In turn, average monthly mortgage payments would rise 37 percent compared to their level in April before the RBA began its rate tightening cycle.
The ANZ/Westpac medium scenario would send the average discount variable rate mortgage to 6.60%, which in turn would increase average mortgage payments by 43% compared to their level in April 2022.
Finally, the bond market high scenario would send the average discount variable rate mortgage to 7.20 percent, raising average mortgage payments by 52 percent from their pre-adjustment level.
It is also worth noting that there is a large proportion of fixed-rate mortgage loans due in the next eighteen months. The average loan rate for these borrowers is ~2.25 percent, which is significantly lower than the variable discount rates illustrated above.
Therefore, the reset of the fixed rate mortgage creates a higher natural adjustment, even in the absence of further OCR increases by the RBA.
The key takeaway is that Australian mortgage holders are facing a painful increase in payments. It’s just a matter of how much?
House prices in Australia will sink
House prices in Australia have already fallen sharply in response to RBA rate hikes.
As illustrated in the chart below depicting the CoreLogic Daily Home Values Index, home values at the five-city aggregate level have fallen 4.5% from their peak, driven by sharp declines in the 7.6% and 4.8% in Sydney and Melbourne:
House values are already falling at their fastest quarterly rate since the early 1980s in Sydney and at the aggregate five-city level.
Tuesday’s 0.5 percent rate hike, coupled with further hikes signaled by the RBA, will drive down home values further, likely resulting in the biggest house price correction in living memory.
This is not hyperbole. The latest RBA Financial Stability Review estimated “that a 200 basis point increase in interest rates from current levels would reduce real house prices by around 15 per cent over a two-year period”.
Based on this model, Australia faces a peak-to-trough decline in real house prices of between 20% and 30%, based on the OCR scenarios above, or between 12% and 20% on the nominal terms assuming inflation remains high.
The RBA is ‘flying blind’ on interest rates
This week, the CBA’s head of Australian economics, Gareth Aird, published research showing that it takes an average of two to three months for mortgage holders to feel an increase in OCR.
This suggests that Australians with mortgages have yet to feel the bulk of the RBA’s rapid monetary tightening, meaning “there is a degree to which the RBA Board is flying blind. It was simply too early for the spending data to pick up the impact of the rate hikes already made.”
Separately, Aird warned that aggressive RBA tightening is “like having five shots of vodka in an hour and saying everything is fine. But you know that soon it will have a great effect.”
I strongly believe that the RBA has raised rates too fast, and should pause to see what the effect is. Otherwise, there is a risk that household consumption will slump, house prices will plummet and Australia will slide into an unnecessary recession.
I also think the RBA will be forced to cut rates in the middle of next year. By then, the lagged impact of rate hikes will have arrived with house prices falling sharply, the economy stagnating, and inflation falling.
After seeing the RBA get too tight, expect to see it pull back and cut rates next year to stave off recession.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith previously worked at the Australian Treasury, the Victorian Treasury and Goldman Sachs.