‘Severe stress’: Interest rate hike fear

Last month, the RBA chose to pause its interest rate increases, which have skyrocketed from 0.1 per cent last April to now sit at 3.6 per cent.

Despite inflation remaining stubbornly high and the lowest unemployment rate in 50 years, economists and most of the major banks are tipping the RBA to hold out on any rate rise in May as there are signs of consumers and households cutting back.

However, some have warned that homeowners could be slugged with an 0.25 per cent rise as inflation only dropped from its peak of 7.8 per cent in December to 7 per cent in the March quarter.

Influential Westpac chief economist Bill Evans has scrapped his earlier prediction for a rate rise in May and instead believes the RBA will press pause again, although future increases were still up in the air.

“Given the uncertainty around the current outlook and a need to contain inflation expectations, the board is almost certain to maintain its clear tightening bias,” he said.

“However, as we move through the remainder of 2023 the credibility of that bias is likely to fade.”

He noted that the latest inflation result is in line with the RBA’s forecast path for eventually achieving its inflation target of 2 to 3 per cent and it would be unlikely to make more calls on rates until its August meeting after more inflation data drops.

ANZ and NAB have also ruled out a rate hike for May.

Commonwealth Bank is the outlier predicting that interest rates will be pushed up by 0.25 per cent, although it has said that the decision will be a “line ball call”.

“Inflation is easing but remains very high. The RBA’s most recent communication continues to include a hiking bias and given core inflation remains in line with the RBA’s forecasts as well as the extremely tight labour market, we favour a 25 basis point hike,” CBA economists said.

This would see interest rates hit 3.85 per cent which would be its peak, the bank noted.

However ANZ is warning that a future rate hike will “ultimately be necessary” to deal with inflation, while NAB believes increases should be over for 2023 but warned “risks remain”.

‘No nasty shocks’

Betashares chief economist David Bessanese believes the March quarter consumer price index (CPI) provided reassuring evidence that inflation likely peaked late last year with “no nasty shocks” in the data.

He has ruled out the potential for May rate hike, despite local inflation remaining “relatively high” compared to the US, but said there are crucial differences.

“For starters, local wages pressure remains more benign than that evident in the United States, meaning more of the increase in inflation in the past year can be attributed to supply-side factors that are less likely to become entrenched,” he said.

“Helping contain wage growth to date has been the speedy rebound in labour force participation following the Covid lockdowns, as the admittedly expensive JobKeeper program kept more employees tied to their former jobs for longer.

“The recent rebound in immigration, though adding to demand, will also likely help contain wage inflation going forward by easing remaining worker shortages.”

Unlike the US there are already signs of a slowdown in consumer spending because of the higher incidence of variable rate mortgages in Australia, he added.

“Australia has closer to 80 per cent variable rate mortgages, which are more sensitive to short-term interest rates, whereas in the United States close to 80 per cent of mortgages a fixed for periods of up to 30 years,” he said.

“Of course, all this could change if wage growth started to rise much more quickly than evident so far and/or consumer spending staged a feisty rebound.

“But barring either of these developments, which I consider unlikely, there’s a good chance the RBA won’t need to raise interest rates again this year.

“Instead, I still see scope for a rate cut on or before Melbourne Cup as the economy slows – and especially if the currently red-hot US economy tips into recession.”

‘Full brunt of rate hikes yet to be felt’

Yet VanEck portfolio manager Cameron McCormack predicts an 0.25 per cent hike as a result of new concerns on the horizon for RBA due to turbocharged immigration and public sector wage increases.

Strong labour force, retail sales and accelerating services inflation cement the case for a rate rise, he said.

“The RBA is clinging to the hope that the labour market will begin to soften this year as higher interest rates start to impact demand, in turn contributing to a higher unemployment, cooling wage and inflation pressures,” he noted.

“However, this is unlikely with Australia’s unemployment rate in recent months trending down and two inflationary pressures surfacing.”

He said the RBA faces fresh concerns on two fronts: the fast pace of immigration pushing up rents in an extremely tight rental market, as well as an anticipated jump in public sector pay following the scrapping/increase of wage growth caps by state governments.

“These pressures add further fuel to the inflationary fire, boosting the case for further policy tightening later in the year. March quarter CPI print showed that services inflation, which is a function of strong wages growth and low unemployment is continuing to accelerate,” he said. “Boosting housing supply to slow rent growth will be a slow burn with RBA only able to influence demand side inflationary pressures.

“Higher mortgage repayments have failed to deter consumers so far, however, 800 000 Australian households are facing a mortgage repayment shock later this year as they shift from ultra-low fixed rate loans to substantially higher variable rates. With so many homeowners yet to come off fixed-rate loans the full brunt of rate hikes is yet to be felt.

“We think markets are over-estimating the likelihood of an RBA pivot.”

‘Severe mortgage stress’

Yet even if the RBA decides to keep interest rates on hold at its May meeting, new research from Canstar shows borrowers who bought in the past two years are likely to be already experiencing severe mortgage stress.

It analysed the impact of variable interest rate rises on recent borrowers who purchased a median priced property with a 20 per cent deposit and an income just big enough to afford the loan.

The research found a borrower who purchased a median priced house two years ago in April 2021 for $643,203 will now be contributing 38.9 per cent of their before-tax income towards their loan repayments.

Meanwhile a borrower who bought in April last year for $805,621 will now be spending an alarming 42.3 per cent of their before-tax income on repayments.

The benchmark for mortgage stress is typically when repayments exceed 30 per cent of a borrower’s before-tax income.

This means both borrowers would be in mortgage stress even before the RBA’s May cash rate call, assuming the borrowers haven’t increased their income above average wage growth since they bought.

Canstar’s finance expert, Steve Mickenbecker said Aussies were emboldened by the outlook that interest rates would remain low into 2024 and as result borrowers in the last two years could now be in severe mortgage stress”.

“Interest rate increases are a blunt instrument that target inflation by forcing borrowers to tighten their belts and lower their spending. All borrowers are impacted to some degree but it takes a tougher toll on recent buyers who have little wriggle room to cut their spending and have had no time to build a buffer,” he explained.

“Borrowers who jumped into the market with loan repayments up to their income capacity in April 2022 are now spending more than 40 per cent of their income on repayments and are likely to be struggling with normal living costs after paying the mortgage.

“Those who beat much of the house price boom and bought a year earlier, in April 2021, are only a little better off.”

‘Banks become nervous’

A borrower who purchased a house in April last year also has the added complication of eroding equity in their property.

Having paid near top-of-market property prices in early 2022 and since watched prices fall, their 20 per cent equity has likely shrunk to 16 per cent.

But the borrower who purchased in April 2021 beat the booming house price growth of the latter half of 2021 and early 2022 and has possibly built their equity to a healthy 34 per cent, the Canstar research showed.

“The problem with falling equity is that the banks become nervous when borrowers come looking for help with repayment relief, as they too are at risk of potentially having to write the loan off,” he said.

“Fortunately, relief appears to be at hand with early promising signs that house price falls are behind us.”

Buyers who found a house too big of a stretch for their income one year or two years ago and opted for a lower priced unit, have not been spared from mortgage stress.

Canstar’s research shows a borrower who purchased a median priced unit in April 2021 for $547,543 with an income just big enough to afford the loan is now likely contributing 37.1 per cent of their before-tax income towards their repayments.

Meanwhile buyers of a unit for $614,449 in April last year will be suffering more with 39.4 per cent of their before-tax salary forcibly going to their loan repayments.

“The good news is that for most borrowers time is the great healer in property ownership. In time the value of your property goes up, incomes rise to cover higher repayments and sooner or later variable interest rates fall,” he noted.