There’s a ticking time bomb in Australia’s mortgage economy, but there could be a solution already in most people’s bank accounts.
When you look at something like monetary policy and interest rate setting, it’s easy to get bogged down in the complexity of the process.
The Reserve Bank is monitoring a long list of various indicators ranging from the overall unemployment rate to the cost pressures facing manufacturers, in their attempts to keep rates at an appropriate level.
Yet despite the challenges of setting interest rates, the actual mechanism by which interest rates affect inflation and the economy in general is actually very simple.
By lowering interest rates, households and businesses see their interest payments on their mortgages and other loans decline, with a significant proportion of these savings being spent in the economy, at least in theory.
On the other side of the ledger, households are earning less interest on their savings accounts and term deposits.
In short, the rate cut aims to effectively inject additional liquidity into the economy in aggregate terms through reduced debt repayments and increased appetite for household and corporate borrowing.
With this additional spending, the aim is for the RBA to meet its inflation target of 2-3%.
On the other hand, when inflation is higher than the RBA’s target, rates are raised to suppress aggregate demand for goods and services from the economy.
This is done in the exact opposite of reducing interest rates. By raising rates, households and businesses have to pay higher interest on their debts, leaving less to spend in the real economy, thereby reducing inflationary pressures.
While households benefit somewhat from the higher interest rates on their savings accounts and time deposits, overall the interest paid on loans by debtors is significantly higher than the interest paid by debtors. banks to account holders.
Where are the prices going?
Currently, there is quite a bit of debate and disagreement about the level to which the RBA cash rate will rise over the next few years and where it will eventually peak.
Westpac – Chief Economist Bill Evans is one of the nation’s most respected monetary policy tea leaf readers. According to him, there will be five rate hikes in 2022, a spot rate of 1.25% by the end of the year and a peak of 2% in mid-2023.
Commonwealth Bank– Of the country’s big four banks, the CBA predicts the lowest peak in the RBA cash rate at just 1.25% in early 2023.
ANZ – ANZ estimates that the cash rate will reach 1% by the end of the year and 2% by November 2023. On a long-term horizon, ANZ’s head of Australian economy, David Plank, estimates that the cash rate will peak somewhere north of 3% around the middle of the decade.
NAB – Of the Big 4, NAB recorded the smallest rate hikes for 2022, seeing the RBA cash rate at 0.75% in December. It is expected to increase further to reach 1.5% by the end of 2023 and 2.25% by September 2024.
The market – The RBA Spot Rate Futures Market is pricing in the largest rate hikes of the five sources covered here today. With a cash rate of 2% expected by the end of the year (about eight rate hikes) and a maximum rate of about 3.3% towards the end of 2023.
How will this affect the economy?
According to research firm Digital Finance Analytics, currently around 27% of outstanding mortgages have a fixed rate of varying terms, with most expiring within the next two years.
For the purposes of today’s snapshot, we will assume that these loans will remain at their fixed rate for the next 12 months.
For every 1% rate hike, household interest payments increase by about $21 billion a year. Thanks to this mechanism, a significant proportion of this $21 billion will not be spent in the economy and inflationary pressures will be reduced, at least in theory.
But with households collectively holding $245 billion in additional savings since the start of the pandemic, this once relatively simple math that underpins the RBA’s monetary policy effort is now much more complex.
For example, if households were to spend 10% of these savings ($24.5 billion) over the next 12 months, in addition to their normal spending habits, the effect of RBA rate hikes in the scale of the economy would actually be mitigated.
A difficult balance
One of the complicating factors for the RBA is that rising interest rates affect households of different demographics very differently. For households with large mortgages relative to their income, their budgets will be significantly affected as they are forced to tighten their belts to make higher interest payments.
On the flip side, there are more affluent households who often own their homes or have smaller mortgages, this demographic holds the lion’s share of the $245 billion in savings that households have amassed since the start of the pandemic.
In areas with high concentrations of these polar opposite populations, two very different Australias could emerge if rates rise as high as some predictions suggest.
In richer and less indebted areas, where the rise in interest rates puts more money in the pockets of savers, household consumption could consequently be higher.
In areas with a high concentration of heavily mortgaged households, the collective tightening of belts is likely to depress household spending across the board as families adjust to higher mortgage repayments for the first time in more than a year. decade.
Tarric Brooker is a freelance journalist and social commentator | @AvidCommentator