Reserve Bank Governor Philip Lowe may not know the exact price of a used 2010 Subaru Forester, but the RBA’s decision to raise interest rates for the first time since Subaru hit the road was entirely related to price pressure in the automotive market and the wider economy.
After the RBA intervened in an election campaign for the first time since 2007, Lowe used a press conference this week to explain why the bank was pushing the official exchange rate down 0.1% – where it has been since. November 2020 – at 0.35%. .
Of greater concern to homebuyers and businesses, Lowe also signaled that a series of rate hikes would be needed to bring inflation under control.
The bank raised rates on the back of last week’s inflation report showing prices rose 5.1% over the past 12 months. The RBA now estimates that inflation could reach 6% and remain high for most of the next two years.
Governments around the world are facing a pincer movement of high inflation and higher interest rates.
In Australia, the situation is even more tense politically. The country’s households are the second most indebted in the developed world, house prices – and the mortgages that underpin them – are at record highs and a large majority of people with a loan have an interest rate variable.
It was a common thread in this week’s debate between Treasurer Josh Frydenberg and the man who wants his job, Jim Chalmers, at the National Press Club.
Neither had a convincing argument as to how they would reduce inflationary pressures.
Frydenberg said world events, including the war in Ukraine and the pandemic, were the main drivers of inflation.
“What we want is for the economy to normalize, and that means making sure we focus on the things that will boost the nation’s productivity and create more jobs; tax breaks, invest in more roads, invest in water infrastructure, invest in telecommunications infrastructure,” he said.
Frydenberg said the coalition’s policies — including its 10-year, $120 billion infrastructure pipeline and improving access to child care — are aimed at boosting productivity and creating more jobs.
“So I would defend our spending, we’ve turned off emergency aid and when it comes to taxes, our record is very clear,” he said.
Chalmers acknowledged the next government faced a serious “fiscal challenge” and said the coalition government had spent, taxed and borrowed more than the last Labor government.
“Immediately, if we are elected, we will audit wasteful spending in the budget, mistakes in the budget, to try to put the budget on a more sustainable footing,” he said.
Chalmers pointed to Labor announcements to cut $3 billion from the budget for outsourcing civil service contractors and consultants, and changes to the way multinational companies were taxed.
Prime Minister Scott Morrison was quick to argue that rates abroad were rising faster than here, pointing to the United States (up half a percentage point on Thursday), Canada (up 0, 75 percentage point since early March), New Zealand (0.75 percentage point since February) and the Bank of England (0.65 percentage point since December).
But it is now. What he didn’t talk about was how the Reserve Bank signaled that more rate hikes are coming. Financial markets estimate that the official exchange rate could reach 4% by September next year.
The cost of living has been a key point of contention throughout the election campaign.
The Coalition used its March 29 budget to provide cost-of-living relief through $250 payments to welfare recipients, a 22.1¢ per liter reduction in fuel excise for six months and an oversized tax compensation for low- and middle-income people that will reach bank accounts after July 1.
At budget time, it was agreed within the Treasury that this amount of cash – about 1% of GDP – was the maximum the government could inject into the economy without causing inflation problems.
Frydenberg stands by this assessment.
“The Treasury was asked during budget estimates if the announcements we made to lower the cost of living would have a material impact on inflation, and they said no,” he said.
What is evident is that the Treasury and the Reserve Bank were wrong in their assessments of domestic inflationary pressures.
The Treasury’s budget forecast predicted an inflation rate of 4.25% this year and 3% in 2022-23. In February, the Reserve Bank predicted annual inflation through 2022 of 3.25%.
Forecasts are often wrong, but not of this magnitude. It’s a bit like Columbus shooting for China but finding the Americas thousands of miles away.
Nor does the official measure of inflation include house prices, which have soared more than 20% in most parts of the country over the past 18 months.
This week’s data from the Australian Bureau of Statistics showed that these higher prices translated into much larger mortgages.
Average new lending in March hit a record high of $600,000, a 70% jump since the Coalition took office.
It’s this increase in the size of our loans that makes interest rate hikes particularly problematic for the Reserve Bank (and why both major parties have spent time on housing policies in recent years).
This week’s 0.25 point rate increase will add about $78 per month to the repayments of a $600,000 mortgage.
Financial markets believe the RBA will raise the cash rate to 0.75% at its June meeting (bringing the cumulative increase in monthly repayments to $197).
At the end of the year, the bank could easily have a cash rate of 1.5%, a cumulative increase of $483 per month.
Philip Lowe has signaled that a cash rate of 2.5% is on his agenda. This would bring the cumulative increase in mortgage repayments from $600,000 to $1,026.
And some economists estimate that it will have to increase to at least 3%. At this point, mortgage payments would be $3,597, down from $2,381 before this week’s monetary policy change.
In total, that’s over $14,500 a year in extra cash (after taxes) that homebuyers should find, in a relatively short period of time.
This is one of the reasons why some analysts think the Reserve Bank won’t drive rates too high: our sheer level of debt will act as a fiscal policy shield. This, of course, collapses if inflation fails to fall back into the RBA’s target range.
Last time interest rates were hiked by the Reserve Bank Julia Gillard was Prime Minister, people were asking for an iPhone 4 and there were only six star wars movies.
Moody’s Investors Services Vice President Alena Chen said the latest interest rate hike, with more to come, will weigh on the housing market.
“Interest rate hikes will pose the most risk to mortgages with large balances and those with repayment amounts close to the borrowers’ maximum repayment capacity,” she says.
“Rate hikes will also weigh on house prices, increasing the risk of delinquencies and defaults on home loans, as borrowers in financial difficulty find it harder to sell their properties at high enough prices. to repay their debt.
Used cars are not included in Australia’s official inflation measure. If they had been, inflation would have been even higher.
The current rate hikes should finally calm the used car market.
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