Reserve Bank Governor Philip Lowe may not know the exact price of a second-hand 2010 Subaru Forester, but the RBA’s decision to lift interest rates for the first time since that Subaru hit the road was all about the price pressures in the car market and the broader 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 taking the official cash rate from 0.1 per cent — where it had been since November 2020 — to 0.35 per cent .
Of more concern for home buyers and businesses, Lowe also signaled a string of rate rises will be necessary to bring inflation to heel.
The bank lifted rates due to last week’s inflation report showing prices growing at 5.1 per cent over the past 12 months. The RBA now believes inflation could reach 6 per cent and remain elevated for the best part of the next two years.
Incumbent governments around the world are dealing with a pincer movement of high inflation and higher interest rates.
In Australia, the situation is even more politically fraught. The nation’s households are the second most indebted in the developed world, property prices — and the mortgages behind them — are at record highs and a vast majority of people with a loan have a variable interest rate.
It was a thread through the debate this week between Treasurer Josh Frydenberg and the man who wants his job, Jim Chalmers, at the National Press Club.
Neither had a compelling argument as to how they would reduce inflationary pressures.
Frydenberg said global events, including the war in Ukraine and the pandemic, were the main drivers of inflation.
“What we want is the economy to normalise, and that means ensuring that we focus on the things that will boost the productivity of the nation and will create more jobs; tax relief, investing in more roads, investing in water infrastructure, investing in telecommunications infrastructure,” he said.
Frydenberg said Coalition policies — including its $120 billion, 10-year infrastructure pipeline and improving access to childcare — were all about boosting productivity and creating more jobs.
“So I would defend our spending, we’ve turned off the emergency support and with respect to taxes, our record is very clear,” he said.
Chalmers acknowledged that 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 to office, we will audit the wasteful spending in the budget, the rorts in the budget, to try and get the budget on a more sustainable footing,” he said.
Chalmers pointed to Labor announcements to trim $3 billion from the budget in the outsourcing of contractors and consultants in the public service, and changes to the way multinational companies were taxed.
Prime Minister Scott Morrison quickly argued rates overseas were going up faster than here, pointing to the United States (half a percentage point increase on Thursday), Canada (up 0.75 percentage points since early March), New Zealand (0.75 percentage points since February) and the Bank of England (0.65 percentage points since December).
But that’s right now. What he failed to discuss was how the Reserve Bank has signaled more rate rises are coming. Financial markets believe the official cash rate could be nudging 4 per cent by September next year.
Cost of living has been a key point of contention throughout the election campaign.
The Coalition used its March 29 budget to deliver cost-of-living relief via $250 payments to welfare recipients, a 22.1¢-a-litre cut in fuel excise for six months and a super-sized low- and middle-income tax offset that will hit bank accounts after July 1.
At the time of the budget, it was agreed within Treasury that this quantum of cash — about 1 per cent of GDP — was the maximum the government could inject into the economy without causing inflation problems.
Frydenberg stands by that assessment.
“Treasury was asked at budget estimates whether the announcements we made to ease the cost of living would have a material impact on inflation, and they said no,” he said.
What’s obvious is that both Treasury and the Reserve Bank were wrong in their assessments about domestic inflation pressures.
Treasury’s budget forecast was for an inflation rate of 4.25 per cent this year and 3 per cent in 2022-23. The Reserve Bank in February was forecasting annual inflation through 2022 of 3.25 per cent.
Forecasts are often wrong, but not by this magnitude. It is a bit like Columbus shooting for China but finding the Americas, thousands of kilometers off the goal.
The official measure of inflation also does not include house prices, which have climbed by more than 20 per cent in most parts of the country over the past 18 months.
Data this week from the Australian Bureau of Statistics showed that those higher prices have translated into much larger mortgages.
The average new loan in March hit an all-time high of $600,000, a 70 per cent jump since the Coalition came to power.
It’s that surge in the size of our loans that makes interest-rate rises particularly problematic for the Reserve Bank (and why both major parties have put time into housing policies over recent years).
This week’s 0.25-point rate increase will add about $78 a month to the repayments on a $600,000 mortgage.
Financial markets believe the RBA will lift the cash rate to 0.75 per cent at its June meeting (taking the cumulative increase to the monthly repayments to $197).
By year’s end, the bank could easily have the cash rate at 1.5 per cent — a cumulative increase of $483 a month.
Philip Lowe has reported a 2.5 per cent cash rate is on his agenda. That would take the cumulative increase on the $600,000 mortgage repayments to $1026.
And some economists believe he will have to go to at least 3 per cent. At that point, the mortgage repayments would be $3597 compared to the $2381 they were before this week’s shift in monetary policy.
In total, that’s more than $14,500 a year in extra (after-tax) cash that home buyers would have to find, in a relatively short period of time.
It’s one reason why some analysts believe the Reserve Bank won’t be driving up rates too high: Our sheer level of indebtedness will act as a fiscal policy shield. That, of course, falls apart if inflation fails to fall back within the RBA’s target band.
The last time interest rates were increased by the Reserve Bank, Julia Gillard was prime minister, people were clamouring for an iPhone 4 and there were only six Star Wars movies.
Moody’s Investors Services vice president Alena Chen says the most recent lift in interest rates, with more to come, will weigh on the property market.
“Interest rate rises will pose the most risk for mortgages with high balances and for those whose repayment amounts are close to borrowers’ maximum repayment capacity,” she says.
“Rate rises will also weigh on house prices, adding to risks of home loan delinquencies and defaults as borrowers in financial trouble find it harder to sell their properties at high enough prices to repay their debt.”
Used cars aren’t included in Australia’s official measure of inflation. If they had been, inflation would be even higher.
The rate rises now on their way should finally take some heat out of the used-car market.
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