Australia could be in for a series of no less than eight RBA rate hikes over the next two years, according to former Reserve Bank board member, John Edwards.
In a column published on the Lowy Institute’s website, Edwards wrote that a number of other central banks around the world have begun to increase their rates, and that he would guess that the RBA was, “already thinking about a program of rate increases that will continue for several years.”
Edwards said that, “if inflation does indeed return to 2.50%, as the Bank now expects, if growth does indeed return to 3.00% ‘within a few years’, as the minutes of the June board meeting predict, if the world economy is indeed picking up, then a policy rate of 1.50% is too low.”
Then what is an appropriate cash rate for the current economic climate? According to Edwards, it might be considerably lower than the 5.20% that was the average over the past 20 years. He suggested the new “equilibrium” rate may be more like 3.50%.
If the RBA sticks to its usual pattern of 0.25% increases, it will need to make eight hikes to reach this 3.50% cash rate within the next two years, Edwards reasoned.
According to him these “eight quarter percentage point tightenings over 2018 and 2019 are distinctly possible, if the RBA’s economic forecasts prove correct.” This forecast includes, “wages growth of 3.50%, inflation of 2.50%, and output growth of 3.00%.”
A large part of the reason rates likely won’t be returning to their former level is the skyrocketing level of household debt in Australia. Edwards pointed out that most Australian mortgages come with a variable interest rate attached, which means they are tied closely to the Reserve Bank’s cash rate.
This means that if interest rates were to rise back to levels around 5.00% it’s possible “that high household home mortgage debt will crimp consumer spending.”
“The bigger the household debt, the more impact a quarter percentage point increase in the policy rate will have on household spending,” Edwards said.
What will a 3.50% cash rate mean for Aussie borrowers?
Edwards said that “now around 5.30%, the standard variable rate on home mortgages will be around 7% or a little more,” if the RBA follows this proposed trajectory.
Mozo’s home loan rate change calculator shows that on a $600,000 mortgage over a term of 25 years, a single 0.25% rate hike from, 5.30% to 5.55% could mean an extra $89 in interest each month. If rates increased by a full 2.00%, that could mean an extra $743 a month, or just under $223,000 over the life of the loan.
While that may seem like a hefty sum, this trajectory depends on the Reserve Bank’s forecast of a 3.50% growth in wages being correct. Edwards also added that “the increases will cause less distress than will be widely observed.”
“Despite the big rise in household mortgage debt, for example, it is still the case today that the total of interest paid today on Australian household mortgages is very much less than it was six years ago, because while debt has increased a bit, interest rates on the total of outstanding debt have fallen a lot,” he said.
“If the standard variable mortgage rate peaked out at around 7% that would still be nearly one percentage point below the 2011 level, and two and half percentage points below the 2008 peak.”
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