Speaking at the Australian Financial Review (AFR) Business Summit on Wednesday (8 March), Reserve Bank governor Philip Lowe reflected on this week’s 25-bp rate increase.

“At our Board meeting yesterday, we discussed the lags in monetary policy, the effects of the large cumulative increase in interest rates since May and the difficulties that higher interest rates are causing for many households,” Mr Lowe said.

“We also discussed that, with monetary policy now in restrictive territory, we are closer to the point where it will be appropriate to pause interest rate increases to allow more time to assess the state of the economy. At what point it will be appropriate to pause will be determined by the data and our assessment of the outlook.”

While he admitted that Australian households have built up considerable savings, he also noted that interest payments are increasing quickly at a time when inflation is also high.

Mr Lowe revealed that, based on the interest rate increases that have already occurred (including Tuesday’s [7 March]), total required mortgage payments are expected to reach 9.5 per cent of household disposal income later this year, which will be around a record high.

“Housing prices have also been declining, although it is difficult to determine the effect of this on spending as there had earlier been a large run-up in prices,” Mr Lowe said. “And the pool of additional savings is spread unevenly across the community. Given this wide range of factors influencing consumption, the Board will be closely monitoring the spending data at each of its monthly meetings.”

AMP head of investment strategy and chief economist, Shane Oliver, said the RBA has “done enough” and should now pause or risk “plunging the economy into a recession”.

“Inflation is still too high and the jobs market remains very tight, but inflation and the jobs market are invariably the last indicators to turn down in an economic downturn,” Mr Oliver stated.

“In particular, we are concerned that the RBA overreacted to the December quarter CPI. Letting inflation and jobs data dominate in driving monetary policy is like driving a car using the rear-view mirror.”

CoreLogic research director Tim Lawless said this rate-tightening cycle has been “both the largest and most rapid on record by some margin”.

“The cash rate setting is now 105 basis points above the pre-COVID-19 decade average (2.55 per cent),” he said, adding that this week’s hike adds roughly $160 per month to repayments on a $500,000 variable rate owner-occupier mortgage.

“Since the rate hiking cycle commenced in May, mortgage repayments on a $500,000 home loan have increased by just over $1,000 per month for owner-occupiers.”

Source: MortgageBusiness

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That makes the analysis of fixed rate movements even more interesting.

Whilst we saw the Reserve Bank of Australia (RBA) start it’s phase of rate increases in mid-2022, the fact remains that the fixed rates offered by our banks had already been increasing for around 6-8 months, starting in late 2021. This is because the Australian banks fund their home loan books from a mix of domestic deposits (ie:  from the money we place in savings accounts here in Australia) and then borrowing they need from overseas markets.  The cost of overseas market borrowings, particularly for longer term debt, was increasing so the banks passed that on via increasing their fixed rate offerings to us mortgage holders.

When the RBA doubled down on this with increases to it’s own official cash rates we saw a savage reaction from the Australian Banks. Whilst the variable rates generally went up in line with movements from the RBA, the fixed rates in some cases lunged upward in excess of 1.00% in anticipation of the further rate increases to come.

Economists were largely divided as to whether the banks had gone too far too early with their fixed rate increases.  The fact that roughly one third of Australia’s banks and mortgage lenders at some stage made downward adjustments to their fixed rate offerings suggests that, at least for some of them, it is indeed the case.

As is always the case, each interest rate increase by the RBA brings you one step closer to the rate peak and we have seen much of the recent debate change from how many more rate increases are still to come – to when they might even start decreasing. Rate decreases, when they start and how quickly they go down will primarily be determined by 3 factors:

1. The cost to the banks of their overseas funding
2. Whether the RBA becomes comfortable that Australia’s rate of inflation is under control, and
3. If Australia does in fact fall into recession.

Nobody has the crystal ball, even the RBA themselves who have a very unfortunate and well publicised recent track record with regard to rate forecasts. So the banks and markets do their own analysis and react accordingly. This has seen some lenders reacting to the most recent RBA rate hike in what us mortgage holders might think is a strange way.

What do I mean by strange?

Well lets looks at Suncorp’s reaction to the latest RBA rate increase on the 8th of February…………

                Variable               ↑           0.25%    (in line with RBA increase of 0.25%)
                Fixed 1yr              ↓           0.40%
                Fixed 2yr              ↓           0.41%   
                Fixed 3yr              ↓           0.51%   
                Fixed 5yr              ↓           0.20%   

And they are not alone, similar adjustments have been made other Australian banks and mortgage lenders.

So why?

It is simply a reflection that Australia’s banks believe we may be closer to the peak of rate increases than not and, particularly if Australia ends up in recession, the next major move in interest rates could in fact be downward.

As always, any home loan rate decision you make should take into account not only your own opinions of where rates might be heading, but also your personal circumstances. It is an important decision that should be made with the guidance of a professional, ideally an MFAA accredited Mortgage Broker.

Source:  Mick Doyle, Accountplan Finance Solutions

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Former Australian prime minister and treasurer Paul Keating infamously stated in 1990, following the release of data showing another fall in Australia’s economic growth rate, that “this is the recession we had to have”.

The Reserve Bank of Australia had raised official interest rates to almost 20 per cent in a bid to combat the asset price inflation that prevailed at the time. 

Australia duly slipped into a recession that officially lasted until late 1991. 

More than 30 years later, there are some echoes from the past. 

The latest surge in inflation and a new round of aggressive central bank hikes in interest rates threaten to push Australia and other developed economies into recession once again.

Some economists believe the current conditions may result in another recession that Australia simply must have. 

This is thanks to the measures taken to offset the economic impact of the pandemic.

Can the causes of past recessions, and the efforts taken to end them as quickly as possible, inform government and policymakers on how to deal with the today’s economic challenges?

Same, but different

On a technical level, the term recession simply defines a period where economic growth, measured by gross domestic product (GDP), declines over two consecutive quarters. 

Generally speaking, recessions are marked by reduced consumer demand. 

This leads to reduced production of goods, rising business losses and failures, higher unemployment, loan defaults and falls in asset prices.

Yet while the symptoms of recessions are broadly the same, their causes are often quite different.

In the case of the early 1990s recession, the causes were broadly linked to the excessive borrowing and spending during the 1980s, which prompted sharp rises in inflation and interest rates. This ultimately culminated in the 1987 stock market crash.

The catalyst for the Global Financial Crisis (GFC) of 2007-2009 was ready access to large borrowings in the US and sudden rises in interest rates. The result was large-scale mortgage defaults in the US that led to a global credit crunch.

While Australia avoided heading into recession during the GFC, the US and many other countries did not. It took years for the US economy to recover.

The current economic malaise has similar symptoms to those that sparked the most recent recessions. 

However, it is largely the result of the fiscal stimulus packages that were enacted by governments around the world to tackle challenges caused by the pandemic.

Governments and central banks pumped huge amounts of money into their economies. 

In Australia, official interest rates were reduced to almost zero, and the RBA made significant purchases of Australian state and federal government bonds to support the economy. 

Some central banks slashed their official rates to below zero.

Low interest rates fuelled spending and inflation, and starting in 2021, central banks have been raising interest rates at a record pace to try to stop inflation in its tracks.

Analysing the latest cycle

The length of recessions can vary considerably. On average, they last less than 12 months, but some can last much longer. 

It mostly comes down to what measures policymakers take to stabilise economic growth.

Warren Hogan, chief economic adviser to Judo Bank, believes the economic shock we’re currently seeing across the global economy arising from the pandemic will be transitory.

“It always was going to be. It’s just some economists and central banks led us to believe that transitory was measured in weeks and months, whereas in the world of macroeconomies you measure it in months and years.”

Hogan says the efforts by governments and central banks to tackle inflation are starting to work, with supply chain pressures easing and some goods prices starting to decline.

The next issue, though, is whether the steps being taken will trigger a spike in labour costs as workers seek out higher wages to address rising living costs.

“We’re still sort of six-to-12-months-into-this-inflation story, and we’re still trying to get policy back to a neutral setting by not helping the economy and making matters worse,” Hogan says.

The recession outlook

Where are we at now? Can Australia avoid a recession?

Hogan says the chances of that are exceptionally low. The more important question is what a recession would look like.

In the absence of a financial crisis, Hogan notes, “it’s likely to be a long, drawn-out, shallow recession”.

“That’s got its good and bad points, because it does contrast with what we’ve typically seen in the last 30 years, which is short, sharp recessions.

“A long drawn-out one will not only potentially make it more difficult to build momentum on the other side, but also it will be socially and politically difficult.”

To this point, Hogan believes government and household finances will come under increasing pressure due to higher interest rates, and this will drive more business failures.

“That will free up labour for other purposes and help relieve pressures on labour markets.

“But the core of the business community, I think, is probably in the strongest position in the economy, particularly in the non-listed area, because they do have a lot of liquidity on their balance sheets.

“This is going to be a very critical time for business, and business will lead us through and out of this recession.”

Source: InTheBlack

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New data from the Australian Bureau of Statistics (ABS) has revealed the Consumer Price Index (CPI) rose by 2.1 per cent over the March quarter.

During the year to March, the CPI rose by 5.1 per cent, pushed mostly by higher dwelling construction costs and automotive fuel, which had soared by 11 per cent.

Trimmed mean annual inflation, which excludes extreme price rises and falls and is the Reserve Bank of Australia’s (RBA) preferred measure of inflation, rose to 3.7 per cent, the highest since March 2009. In the previous quarter, the trimmed mean came to 2.6 per cent.

On a quarterly basis, the measure was up by 1.4 per cent in the three months to March – the strongest movement since the ABS began its records in 2002.

The RBA has previously signalled that it would only raise the cash rate from its current record low of 0.1 per cent when it was convinced that its target range of 2-3 per cent annual inflation could be sustained – meaning annual wages growth would also need to rise to above 3 per cent.

Earlier in April, Reserve Bank governor Philip Lowe confirmed the ABS inflation data, alongside new wages data would be key to determining the path of the cash rate.

Many economists have forecast the first of a series of cash rate increases will take place in June.

Looking at one of the larger drivers for the inflation surge, new dwelling prices for purchases by owner-occupiers were up by 13.7 per cent during the year to March – the largest rise since September 2000, following the introduction of the GST.

Michelle Marquardt, head of prices statistics at the ABS explained newly built dwellings had been hit by “continued shortages of building supplies and labour, heightened freight costs and ongoing strong demand”.

“Strong demand combined with material and labour supply disruptions throughout the year resulted in the highest annual inflation for new dwellings since the introduction of the GST,” Ms Marquardt said.

The largest rises in newly constructed home prices were recorded in Perth (up 15.8 per cent), followed by Brisbane (+6 per cent) and Melbourne (+4.7 per cent).

Ms Marquardt noted there were also fewer construction grants from the government compared to the previous quarter, as HomeBuilder and other similar state-based programs had come to an end.

“These grants have the effect of reducing out of pocket expenses for new dwelling purchases,” the ABS explained.

Annual price growth for new houses had continued to shoot up from the June quarter last year, when it had been 1 per cent. But the new result is still a sizeable rise from the previous quarter’s annual growth rate of 7.5 per cent.

Meanwhile, petrol, which was up by 11 per cent, had rocketed up on the back of a global price shock, following the Ukraine invasion and eased COVID restrictions.

“Annual price inflation for automotive fuel was the highest since the 1990 Iraqi invasion of Kuwait,” Ms Marquardt said.

The largest rise was observed in Adelaide (up 12.6 per cent), followed by Darwin (up 12 per cent) and Brisbane (up 11.9 per cent).

Ms Marquardt reported there had been fuel price rises across all three months of the March quarter.

Notable rises were also recorded across the food group (+2.8 per cent), reflecting high transport, fertiliser, packaging and ingredient costs, as well as COVID-related disruptions and herd restocking due to favourable weather.

Source: MortgageBusiness

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Speaking to the House of Representatives standing committee on economics for its hearing on monetary policy on Friday (11 February), the governor of the Reserve Bank of Australia (RBA), Philip Lowe, was questioned on the accuracy of the bank’s forecasting given an increasing divergence with market economists.

Committee chair Jason Falinski MP asked the central bank governor why there had been a “marked difference” between what the RBA is forecasting and what market economists are predicting when it comes to the market conditions that would lead to an increase in the cash rate.

The difference largely comes down to when inflation will be “sustainably” within the target rate of 2-3 per cent.

For example, several of the major banks had touted August or September as the month in which the RBA would first raise rates, however some are now revising their forecasts, outlining that the cash rate may rise as early as June 2022. According to Commonwealth Bank senior economist Gareth Aird, inflation could be stronger than the RBA is forecasting and therefore lead to the central bank to raise rates in four months’ time.

However, the RBA’s forecasts have been suggesting that annual underlying inflation will only reach the middle of its 2 to 3 per cent target band by the end of 2023 (revised up from a previous projection of 2024).

While members of the RBA board noted at the recent February meeting that, in underlying terms, inflation had picked up to 2.6 per cent, they flagged that this was the first time in more than seven years that underlying inflation had been around the midpoint of the target range.

Although inflation had picked up, members agreed it was “too early” to conclude that it was sustainably within the target band, according to the board meeting minutes, given that wages growth remains “modest” and there are “uncertainties about how persistent the pick-up in inflation would be as supply-side problems were resolved”. 

‘We’re going to be right sometimes and we’re going to wrong sometimes’

Responding to the question, the RBA governor reiterated comments made to the National Press Club earlier this month that economic indicator had “turned out much better than we had expected”.

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“[W]e thought the unemployment rate would be 6 per cent now, not 4.2 per cent. We thought inflation over the past year would be 1.5 per cent or a bit more, and it’s turned out to be 2.5 per cent. The economy has done much better than we thought, and inflation has been higher,” he explained. 

“Our forecasts at the beginning of last year were not that much different to the market forecasts. Professional economists had similar forecasts to our own, and so we’ve all been surprised, and we’re humble about our ability to forecast.

“There are always going to be forecast errors; we don’t have a crystal ball. What we try to do is explain to the public the forces that are driving our forecasts and provide some general details.

“We’re going to be right sometimes and we’re going to wrong sometimes, and last year things turned out better. That, in some people’s eyes, has damaged our credibility. I accept that, but we don’t have a crystal ball and we’re living through incredibly difficult times and having to process in real-time the effects of shocks that we’ve not dealt with before. 

“We get some things right and some things wrong.”

Mr Lowe later said that it was “plausible” that the central bank would raise rates later this year, but caveated that by saying it was dependent on “the data, the evidence, the outcomes of inflation and the trajectory of inflation”.

“It is certainly plausible that interest rates go up this year, but we are going to see what the evidence tells us. It may be that participants in financial markets think the evidence is going to come in in such a way that inflation will be higher, stronger and more persistent. They may well be right; we don’t have a crystal ball. They may be right, but our judgement, for better or worse at the moment, is that the evidence of higher inflation is only going to emerge slowly over time,” Mr Lowe said.

The RBA governor outlined this was based on two judgements: that supply-side pressures will gradually resolve themselves and patterns of demand in the economy will normalise; and that the inertia in the labour market would continue.

“When we come back in six months time, we will see how those judgements have played out,” he told the committee.

“It is certainly plausible, if the economy tracks in line with our central forecast, that an interest rate increase will be on the agenda sometime later this year. We are looking for certain things we have talked about before: evidence that inflation is sustainably in the 2 to 3 per cent range, evidence about the development of labour costs and evidence about the resolution of supply chain problems. They are the things we are looking at. We get the CPI quarterly. I think just having one more CPI is not enough for that evidence to emerge, but, over time, if things line up in a positive direction then we will be discussing this later in the year.”

As well as discussing the nuances of forecasting, the central bank governor also reflected on how rate rises would impact mortgagors.

He said: “Three years ago, the median borrower had a buffer equivalent to one year’s interest and mortgage repayments. We used to think the median borrower having a one-year buffer was a big buffer. Today the median borrower has a buffer of more [than] two years in mortgage repayments. 

“Households have, by and large, been pretty sensible [during COVID]. They’ve spent some of the money, but they’ve also saved a lot, and they’re increasing their mortgage buffers which will stand them in good stead for the day that interest rates do go up.”

However, Mr Lowe acknowledged that while the “median borrower” won’t have to adjust their mortgage repayments for a modest increase in interest rates, he added that there is a “large number of households that don’t have the buffers and they will have to increase their mortgage payments”.

“We look at these buffers a lot because it will influence how households react to higher interest rates,” he said.

Source: MortgageBusiness

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Reserve Bank of Australia (RBA) assistant governor (economic) Luci Ellis appeared before the House of Representatives standing committee on tax and revenue on Monday (15 November), for its ongoing inquiry into housing affordability.

Reflecting on the serviceability of mortgages, the economist told the parliamentary committee that she had observed the majority of borrowers paying off more of their home loans than required by their contracts, particularly during COVID.

“Now, people have been socking away money in offset accounts and redraw accounts during this period. And particularly where, you had lockdowns, some people were not spending as much as they ordinarily would,” Dr Ellis explained.

She had made the comments as economists have speculated a cash rate movement, from the current historic low of 0.1 per cent, is due sooner than the RBA’s previous forecast of 2024. Some have tipped an increase is on the cards as soon as November next year.

The Reserve Bank itself has acknowledged that inflation has picked up faster than it expected, which could eventually result in the cash rate rising in 2023.

Recent survey data from the Finance Brokers Association of Australia (FBAA) has found three-quarters of borrowers and renters believe that rising interest rates would place pressure on their financial position.

Around 56 per cent of the survey participants had said that if rates were to increase, they would need to consider refinancing their mortgages.

But Dr Ellis believes differently.

“One important context here is, if and when rates do eventually rise, a lot of people will not actually need to raise their actual repayment, because they’re already paying more than they need to, according to their loan contract,” she told the parliamentary committee.

Last week, the Reserve Bank released research around liquidity, tying a rise in household liquidity in recent decades to rocketing house prices.

While aspiring buyers needed to accumulate greater levels of cash while saving for a deposit, those who already had a mortgage have been incentivised by the threat of future shocks to make higher repayments than needed and to build up a greater cash buffer.

Offset accounts were also found to be a primary driver of raised cash buffers with mortgage debt, at least since the 2010s – with the RBA noting borrowers using the product tended to have larger buffers on average and also experienced a greater rise in buffer over time.

Mortgages with offset accounts currently comprise around 40 per cent of home loans in Australia, while mortgages with redraw facilities make up around 70 per cent.

Dr Ellis called the widespread use of offset and redraw accounts “one of the most desirable features of the Australian institutional framework”.

“Other countries do not have the widespread use of offset and redraw accounts, which are the most tax-effective form of precautionary saving ever invented,” she commented.

Rates are a balancing act

Dr Ellis noted that setting the interest rate at low levels has pushed up housing prices by allowing consumers to service a larger mortgage on the same income, but the alternative wasn’t desirable for the central bank.

“The response I would have is that the alternative was being a high inflation country, much higher inflation than our peers,” she reported.

“And that would involve difficulties attracting capital, it would involve economic instability and there’s swings and roundabouts.”

Dr Ellis also reflected on the burden of a mortgage under different settings.

“If you conceptualise… you buy a home, you live in it, you pay off your mortgage – in a high interest rate world, you end up paying more interest overall, but your income probably rose more quickly and so those repayments declined more quickly, you inflated your debt away more quickly,” she said.

“In a low inflation world, you end up paying less interest overall cumulatively, but the burden of that repayment doesn’t inflate away quite as quickly when you’ve got lower nominal income growth.”

Source: MortgageBusiness

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We haven’t seen it in years. The RBA  has not raised interest rates for more than 130 months. But we all knew it had to come at some point. It seems that time has come.

We have seen the biggest movement in interest rates for a long time, but it’s not due to the RBA. Banks are taking action and increasing their interest rates.

CBA was the first to move. It took a machete to its flagship basic variable rate, cutting it by 40 points; but to make that balance out on the books, it increased all other major fixed rates. Westpac was second in line, raising its rates for two-, three-, four- and fi ve-year fixed interest rate loans.

Why are fixed rates going up?

Managing director and founder of Finsure, John Kolenda, explained.

There’s an inverse relationship between interest rates and inflation; if one rises the other has to fall. The RBA has flagged no interest rate rises until 2024. The only reason for an earlier rise would be to seize rising inflation and drop it back to where it needs to be.

Kolenda believes there is pressure on inflation. We have seen this in the increasing cost of goods and services throughout the COVID pandemic.

This could mean the RBA is forced to review interest rates earlier than planned.

Other indicators of inflation are bond prices and the price of money. The RBA has used bonds and funding terms to support the economy throughout COVID, with a lot of success. As it reduces the support, this can lead to inflationary pressure.

Banks borrow from overseas and could be paying a higher rate. This, and rebounding economies, also builds inflationary pressure.

How does this lead to banks increasing rates?

As the cost of money and borrowing rises, banks will increase rates to compensate.

Inflationary pressure is high in the US and New Zealand as these economies rebound from COVID. The same is expected in Australia soon.

Cashed-up customers are coming out of lockdown ready to spend. Confidence is increasing, as is the cost of goods and services. Pressure to increase wages is expected as businesses struggle to find staff. All of these pressures will lead to increasing inflation and the banks needing to raise interest rates to claw back costs. Westpac and CBA moved first; it’s expected that other banks will follow shortly.

Other regulatory influences

Cashed-up buyers coming out of lockdown want to buy new homes. It’s not just the weather that’s heating up; the real estate market is too. While it’s a great boost if your nest egg is in your home and you are looking to cash out and downsize, it’s not all good news. Skyrocketing prices put pressure on affordability and the cost of living; together with inflation, it’s a recipe for disaster.

To reduce the impacts of skyrocketing house prices and inflation risks, APRA has recently made some changes to mortgage lending, because it’s concerned about people borrowing more than they can service when interest rates are likely to go up. APRA has increased the interest rate buffer that banks must apply to loans at application stage from 2.5% to 3%. This means borrowing capacity is reduced.

What this means for buyers 

This buffer rate rise does not affect an existing mortgage, and the interest rate won’t change. What will change is how the bank, during the application process, views a borrower’s ability to service a loan.

It also won’t affect the customer if they are not borrowing at their maximum capacity. The biggest impact will be on investors who are more likely to be borrowing closer to their limit than owner-occupiers.

What this means for sellers

Given only a small percentage of customers borrow at capacity (CBA reports 8%), sellers can still expect high property demand.

Source: BrokerNews

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With regard to the former, The Organisation for Economic Co-operation and Development and International Monetary Fund this month separately backed a review of the RBA, highlighting its failure to achieve its inflation target for several years. 

But a long and costly inquiry is unnecessary. 

The RBA is an institution which is both admired internationally and a model of best practice in Australia. 

Using a root and branch inquiry to explain why it has not achieved its inflation mandate when the target is out of line with the evolution of the Australian and global economies over 30 years, and with the practices of all the major overseas central banks, seems unnecessary.

Set at 2-3 per cent over the cycle, the target was first referred to in August 1992 when inflation had averaged 6.4 per cent over the previous seven years, the 10-year bond rate was around 8.5 per cent and the cash rate 5.75 per cent.

The structure of the yield curve and the level of the cash rate allowed ample flexibility to reach the target, which was formalised between the RBA Governor and the Treasurer in 1996. 

But since 1992, the world has changed (technology, demographics, globalisation, lower unionisation) and the flexibility of central banks has been severely curtailed as policy rates have fallen into their lower bounds around zero (or negative in some cases). 

Yet, we are still asking the RBA to achieve the same target. 

Other central banks have lower targets – the US Federal Reserve and ECB both target a symmetric 2 per cent, the Bank of England targets 2 per cent, and both the Bank of Canada and Reserve Bank of New Zealand target a 1-3 per cent range. 

The argument against lowering the target seems to be that it would lower inflationary expectations and change economic behaviour.

But measures of expectations are much closer to 2 per cent than 2.5 per cent, suggesting there should be limited incremental impact on expectations of a change to 1-3 per cent.

I believe markets would actually welcome a move to align Australia’s target with other central banks. 

Before the current situation, where we are faced with an official forecast that the cash rate is set to remain at near zero for four years to achieve the target, arguments to lower the target were not as material as we face today.

The Treasurer could implement such a change after the next election, in line with the precedent of some previous elections where the Statement on the Conduct of Monetary Policy – which specifies the inflation target – has been renewed after consultation between the government and the Bank.

Governor Lowe would then have the flexibility to still pursue his objective of lifting inflation, wages growth and lowering the unemployment rate  – without having to over stretch and risk a dangerous imbalance in the housing market by pursuing an unnecessarily ambitious target.

Ironically, Westpac expects that due to the unprecedented mix of demand and supply factors following the COVID crisis, the RBA will achieve its inflation and full employment objectives by early 2023, allowing a move away from the emergency policy settings well before the official forecast of 2024.

However, in subsequent cycles, the issues we have faced since 2014 will re-emerge, highlighting that the inflation target is still inappropriate.

Achieving the target much earlier than the RBA expects would allow the Governor to avoid the dangerous impact on asset markets of four consecutive years of a 0.1 per cent overnight cash rate.

Imagine where the housing market might go if our forecasts are wrong and the RBA’s forecast is correct, with the official cash rate being held near zero until well into 2024!

Dwelling prices have already lifted by 17.5 per cent over the last year, the strongest annual house price increase since 2002, and affordability measures for first home buyers are stretched. 

As has been well flagged, APRA will likely step in and introduce some controls on new lending, such as debt to income limits and increases in the serviceability rate used in loan assessments.

Such policies will certainly impact income stretched first home buyers and upgraders, particularly in the high- priced cities.

Investors who hold multiple properties and have been taking advantage of rising valuations on existing investments to acquire more properties will be affected. But new cashed up investors who are becoming cautious about a volatile equity market will be attracted to the housing market, with fixed funding costs generally lower than rental yields, while established sophisticated investors typically have access to a wide range of income sources.

So, we may be heading for a number of years when our housing markets are subject to some forms of direct controls, which still favour investors, and may prove to be less effective than expected.

In addition, we will see the usual efficiency risks around pricing signals and the movement of funds away from the regulated sectors to the unregulated but less capitalised sectors.

The question is the value of the trade-off: half a percentage point on the inflation rate relative to the prospect of a long period of distortive controls favouring borrowers who can find ways around those controls, a surge in house prices to unsustainable levels, and the associated vulnerability of borrowers to any eventual upswing in rates.

My view is that the RBA’s inflation target is now too high.

It’s time for an adjustment to 1-3 per cent to avoid some of these distortions.

Over to you Treasurer and the RBA. 

Source: Westpac

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