The Commonwealth Bank is warning of the risk that a three-month mortgage delay poses to the economy if the Reserve Bank continues to aggressively raise interest rates.
Key points:
- The RBA is expected to raise the cash rate target by 0.5 percentage point in September.
- CBA says rate hikes take about three months to affect clients’ cash flow
- That means most adjustable-rate mortgage customers haven’t yet felt the cash flow effects of at least the last percentage point of rate increases.
The RBA has already raised interest rates for four months in a row, quickly bringing its official cash rate target from a record low of 0.1 percent to 1.85 percent.
It is later expected to raise rates yet again, with most analysts and traders expecting another half percentage point hike to take the cash rate to 2.35 percent, the highest since early 2015.
But most borrowers are barely feeling the effects of the first two rate hikes, according to Commonwealth Bank head of Australian economics Gareth Aird.
“Interest accrues from a lender’s effective rate change date, which is typically about two weeks after the RBA raises the effective rate,” he said.
“This interest is added to the borrower’s outstanding debt. But from a cash flow perspective, the impact is not felt for three months on average for a CBA client.
“Delays between other lenders vary, but we estimate that, on average, the delay is around two to three months among major lenders.”
Aird said that means most adjustable-rate mortgage customers have only seen their minimum payments adjusted to reflect the RBA’s first two rate hikes, and not yet the percentage point hikes made in July and August.
“This means that most of our borrowers have only felt the impact of a 25 basis point increase in their cash flow (or potentially, as of this week, the cumulative impact of the May 25 and June 25 rate hikes). rate increase of 50 basis points).”
RBA ‘clear risk’ ‘flying blind’
So it’s no surprise that the full effect of the rate hikes the RBA has already delivered are yet to be felt at cash registers across the country.
Retail sales reached an all-time high of $34.7 billion in July, up 1.3% from the previous month and 16.5% from a year earlier.
Olivia Cummings, director of jewelery company Cleopatra’s Bling in Melbourne, said trading conditions were unpredictable but generally strong.
“We’re doing pretty well considering the general stress people are experiencing with the rising cost of living,” he told The Business.
“People are inclined to get custom gold pieces, because I think you associate gold as a long-term investment, something that won’t lose value.”
But the 34-year-old businessman is nervous about what could happen if the Reserve Bank’s cash rate increases remain aggressive.
“I’m not an economist, but I would say that it doesn’t seem logical to me to add additional stress to people who might be spending their money in the local economy,” he said.
Gareth Aird is an economist and has similar concerns.
“The rapid pace at which the RBA has tightened policy, overlaid with a full appreciation of the lags between rate hikes and the cash flow impact on a home borrower, means that there is a degree to which the board of the RBA is blind,” he said.
“It’s just been too early for spending data to pick up the impact of rate hikes already delivered.”
This, combined with sluggish wage growth, cost-of-living pressures and high levels of debt for many Australian households, has convinced Aird that the bank should taper its rate hikes going forward.
While he is among the consensus expecting another half percentage point rate hike later today, he thinks the Reserve Bank should taper rate hikes to a quarter percentage point thereafter with a spike of 2.6 or 2.85 percent in October or November.
“There is a clear risk that the RBA will continue to tighten policy aggressively because it appears that demand in the economy is not slowing enough to put the desired downward pressure on inflation,” Aird warned.
“But that will happen over time as the rate hikes take effect. In CBA, for example, by December, the impact of the already announced rate hikes on monthly cash flow for mortgage holders will quadruple in comparison with July.
Fixed rate roll-off creates a ‘natural fit’
Higher interest rates don’t just affect your customers; Mrs. Cummings has to make her own mortgage payments on the apartment in which she lives.
“I am in a variable [loan], unfortunately. I didn’t fix my fee,” she said.
“We’re in a kind of period where [the business] I want to be able to take more risks, but taking risks in this current climate feels a little scarier than usual.
“I take risks, so I probably will and I’ll keep working hard.”
But Aird warned that the low-rate grace period for most of those who fixed their loans is running out fast.
“There is a large proportion of fixed-rate mortgage loans that will come due in the next 18 months,” he said.
“This creates a natural tightening even with the RBA on hold (note that the average loan rate for a borrower rolling over a fixed-rate loan over the next eighteen months is around 2.25 per cent. This rate is significantly lower than the standard variable rate, which is likely to rise to 4.5-5.0 percent with a 2.60 percent cash rate).”
At a time when the Reserve Bank is under even greater pressure than usual, Aird concluded his note with this ominous warning.
“The Australian economy is largely in the hands of the RBA.”
Leave a Reply