Many households are yet to feel the impact of higher mortgage repayments but further interest rate hikes will start to “bite” as the cost of living also rises, Reserve Bank of Australia governor Philip Lowe has warned.
Mr Lowe warned both interest rates and inflation will continue to climb higher this year, but he does not expect the massive rate rises to be predicted by financial markets nor that the economy will end up in a recession.
Mr Lowe said Australians should be prepared for more interest rate increases after the RBA’s May and June hikes, the first increases in the cash rate since 2010.
The RBA governor has told Australians to be prepared for more interest rate increases. Picture: Getty
Financial buffers including more than $ 200 billion in additional savings built up by households during the pandemic helped cushion the impact of the RBA’s first two rate hikes, although Mr Lowe acknowledged increased mortgage repayments have “clearly hurt some people”.
“The first increases in interest rates that we’ve done really haven’t affected most people’s mortgage repayments that much because people have built up big buffers and many people were paying more than they needed to,” he said on Tuesday.
“But as interest rates start to rise those buffers will be eaten into and given the fact that households have more debt than they used to, it will start to bite and we’re very conscious of that.”
Economists at the major banks expect the cash rate to rise from the current 0.85% to 2.1% – and 2.35% in the case of ANZ – by the end of 2022, but that it won’t reach as high as the 4% being priced. in by financial market traders.
Addressing the American Chamber of Commerce in Australia, Mr Lowe indicated a 4% cash rate by the end of the year was unlikely.
“To get to 4% we would have to increase interest rates by 50 basis points at the remaining six meetings this year and have a 75 basis point increase in there as well,” he said.
“I would observe that that would be the sharpest and quickest tightening of monetary policy that we’ve ever experienced in the inflation-targeting regime.
“An increase in interest rates of that magnitude would have a first-order effect on people’s mortgage payments, it would affect confidence, I think it would slow the economy quite a lot.
“I don’t think it’s particularly likely but the market has been a better judge of where interest rates are going than we have over the past few years, so you’ve got to pay attention.”
Mr Lowe last week reiterated that it is reasonable for the cash rate to get to 2.5% at some point.
Further rate hikes and an inflation spike on the way
While the central bank now expects inflation to spike to 7% later this year, Mr Lowe said the RBA has not predetermined how high rates need to go as it charts a course to bring inflation back to its 2% to 3% target range.
“The level of interest rates is still very low for an economy with low unemployment and that is experiencing high inflation,” he said.
“I want to emphasize though that we are not on a pre-set path. How fast we increase interest rates, and how far we need to go, will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labor market. “
The RBA is tipped to announce another big rate hike of 50 basis points in July. Picture: Getty
After lifting the record-low cash rate by 25 basis points in May and by a super-sized 50 basis points in June, economists at all four major banks expect the RBA will hike the cash rate by 50 basis points again in July.
Asked if the RBA would lift rates in July by a huge 75 basis points like the US Federal Reserve did last week, Mr Lowe said he expected the board would be repeating its June discussion about whether to move by 25 or 50 basis points.
“I expect that next month we’ll be having the same discussion at our board meeting – 25 or 50,” Mr Lowe said.
The RBA has lifted its forecast for inflation given rising in petrol, electricity and gas prices. It now expects inflation to peak at around 7% in the December quarter before beginning to decline by early next year.
Mr Lowe said while there will be a spike in inflation, people should have confidence that it will come down again.
Australians face rising interest rates as well as higher prices including for petrol, electricity and gas. Picture: Eugene Hyland
Mr Lowe said higher interest rates would help alleviate some of the inflation pressures being experienced globally and in Australia, although it would take time for inflation to get back into the RBA’s 2-3% target band.
“It’s going to be some years, I think, before inflation’s back in the 2-3% range. But over the next couple of years it will gradually come down.”
Mr Lowe did not expect Australia to slip into a recession.
“We don’t see a recession on the horizon,” he said.
“If the last two years have taught us anything, we can’t rule anything out. But our fundamentals are strong and the position of the household sector is strong, and firms are willing to hire people at record rates. It doesn’t feel like the precursor to a recession.
“And interest rates, while they’ve gone up, are still low. The cash rate is still less than 1% at a time when the unemployment rate is at a 50-year low, so the fundamentals here are still pretty positive.”
Lowe sad that rate hikes are difficult for some people
Mr Lowe said while household balance sheets are generally in good shape, a lot of people have not previously experienced a period of rising interest rates.
“Many households are also experiencing a decline in their real income because their normal income isn’t matching pace with the higher rate of inflation. In addition to that, housing prices are now declining in our major cities.
“So real incomes are going backwards, housing prices are declining and people are having to cope with higher interest rates.
“Given these various considerations, we will be watching household spending very closely as we chart our way back to 2% to 3% inflation.”
Mr Lowe said the median borrower has a buffer well in excess of a year’s mortgage repayments and some people have two years’ worth, but others are not in that position.
“We know that while the median borrower has built up big financial buffers, there is a group of borrowers who have very skinny buffers – people who’ve taken out their first housing loan in the last year or so, who’ve bought a bigger house in the past couple of years and borrowed as much as the bank would lend them. “
Mr Lowe said he was concerned about people who borrowed too much and could get themselves into trouble, adding the constant message over the last few years was to have buffers and be prepared for higher rates.
“Some people will have problems and as an individual, it saddens me. But I take pride in the fact that this country is closer to full employment than it’s been in 50 years and that’s important.”
RBA admits its reputation has been damaged
The RBA accepts its credibility has been damaged by the way it handled its yield target, which was introduced in March 2020 as part of a package of emergency measures during COVID.
The RBA board’s review of the yield target concluded it was successful in lowering funding costs and supporting the supply of credit in Australia, which Mr Lowe said helped the economy recover from the pandemic.
Lending rates fell considerably after the introduction of the target and wider package, with banks lowering their three-year fixed-rate loans to well below the rate on new variable loans for the first time and the share of fixed-rate housing loans rose to a. record high.
“So these adjustments did help the housing market in Australia in a period of great uncertainty and also helped household finances during this difficult period,” Mr Lowe said.
The RBA board admits the messy way it exited its yield target policy caused some reputational damage to the central bank. Picture: Getty
Mr Lowe said with hindsight, it could be argued that there was too much focus on the downside risks to the economy and the need to insure against them during the dark days of the pandemic, and too little focus on the possibility that things would work out. better than expected.
The target was construed as a form of time-based guidance, an interpretation that Mr Lowe said was reinforced by the bank’s communication that in its central scenario interest rates were unlikely to rise until 2024.
He said the yield target was not a flexible policy instrument as times changed and created communication challenges given the board’s decisions were in fact dependent on the state of the economy and not on the calendar.
The board dropped both its 2024 timeline and the yield target in November last year, but the exit was messy.
“[The board] recognizes that the way the target ended in late 2021 was disorderly and it did cause some reputational damage to the RBA, “Mr Lowe said.
“We accept that earlier communication from the bank could have eased the situation, although the end of a target that was losing credibility was always likely to be associated with some volatility in market prices.
“The board has not ruled out using a yield target again in extreme circumstances, but it views the probability of doing so as low.”
The RBA is reviewing its policy settings during the pandemic and also faces an independent review of its operations. Picture: Getty
The RBA board is also reviewing its bond purchase program and the bank’s approach to forward guidance.
Treasurer Jim Chalmers is expected to soon announce details of an independent review of the operations of the RBA and monetary policy.
Mr Lowe said the RBA welcomed the review as an opportunity to learn and respond on public policy issues.
“I’m not worried that it’s going to dig up anything,” he said.