An upwards move was anticipated, given soaring inflation, but the timing and magnitude of the lift is likely to be regarded as controversial, given the looming Federal election. By lifting the cash rate during an election month, the RBA has sent a clear message it will make decisions based on its mandate and not be swayed by the political cycle.
The cash rate had remained at the record low 0.1% setting since November 2020, marking an 18-month period where interest rates were held at emergency lows. The low interest rate setting coincided with surging housing values; between November 2020 and April 2022 national housing values have increase by 27.0%, adding approximately $159,300 to the median value of an Australian dwelling.
The lift in the cash rate comes as annual core inflation, based on the average of the trimmed mean and weighted median, reached 3.5% in the first quarter of the year. This is the first time core inflation has been above the RBA target range since March 2010. While some of the drivers of high inflation may be transitory, such as higher fuel costs, others are less so, such as the cost of new dwellings, higher education costs and rental inflation.
Although inflation has broken out of the target range, there was some speculation the RBA would wait for confirmation of wages growth, via the ABS Wage Price Index, which is released later this month, before raising the cash rate. The most recent wages data, to the December quarter, was on an upwards trajectory after rising by 2.3% over the year (2.8% including bonuses). The RBA was looking for annual wage growth in excess of 3.0%.
Clearly there was enough indirect evidence of wages growth from the RBA’s business liaison program to make a move on the cash rate without the ‘official’ update on wage costs. Based on their liaison program, the Bank had earlier noted private sector wages growth continued to pick up through the March quarter, along with indications that firms planned to expand their headcount. Other factors including higher job vacancies and job advertisements along with an unemployment rate of just 4.0% and trending lower, also foreshadow higher wages growth.
What do higher interest rates mean for the housing sector
Higher interest rates are set to add to the downwards pressure on housing growth rates, which were already losing steam or, as in the case of Sydney and Melbourne, trending into negative territory due to factors including affordability constraints, higher fixed term mortgage rates and lower levels of consumer sentiment.
As the cash rate normalises, we can expect housing markets to lose further momentum. A higher cash rate implies higher variable mortgage rates, a reduction in borrowing capacity and tighter serviceability assessments for prospective borrowers. Past research from the RBA has pointed to ‘high end’ housing markets with higher investor concentrations being more sensitive to changes in interest rates in the short term. This may be why Sydney and Melbourne markets are already seeing price declines, with more affordable housing markets expected to eventually follow the downward trend.
Under a 100 basis point lift in variable mortgage rates, a new borrower in Sydney could be facing a rise in monthly mortgage costs of $486, while under a 200 basis point rise, monthly mortgage costs could be $1,005 higher than current levels.
The extent of any housing market downturn depends on how high and how fast interest rates rise, but also a variety of other factors. Labour markets are currently showing the lowest unemployment rate since the mid-1970s, and conditions are set to tighten further. Such a low unemployment rate, along with an expectation for higher income growth, should keep mortgage distress and forced sales at relatively low levels.
Additionally, as we enter a period of higher interest rates, borrowers are generally well ahead of their mortgage repayments. The RBA has recently noted in their latest financial stability review the median repayment buffer for owner occupiers with a variable mortgage rate had grown to 21 months of scheduled repayments in February 2022, up from 10 months at the start of the pandemic. Even with a two-percentage point rise in mortgage rates, the median repayment buffer would reduce back to 19 months, which is still substantial. With the median household well ahead of their mortgage repayment schedule, the risk of households falling behind on their mortgage is reduced.
Mortgage distress should also be minimised to some extent by mortgage serviceability assessments at the time of the loan origination. All borrowers would have been assessed to repay their mortgage under a scenario of mortgage rates being 2.5 percentage points higher than the origination rate, and since October last year, borrowers were being assessed at mortgage rates of 3 percentage points higher.
Under these serviceability scenarios, borrowers should be able to accommodate higher mortgage repayments costs, although such a rapid rate of inflation could create some challenges for borrowers with thinly stretched budgets.
The recent rise in fixed term mortgage lending is another factor helping to insulate home owners from higher interest rates. Through the middle of last year, 45% of housing loans were funded on fixed rate terms, temporarily shielding those borrowers from rate hikes. While they will need to refinance down the track, by that time labour markets are likely to have tightened further and income growth picked up.
How much could mortgage repayments rise for a new owner occupier borrower?
Monthly mortgage repayments | ||||||||
Median dwelling value | Loan principal @80% LVR | @ current average variable rate | with a 100bp rise | with a 200bp rise | Additional monthly loan cost with a 100bp rise | Additional monthly loan cost with a 200bp rise | ||
Sydney | $1,127,723 | $902,178 | $3,560 | $4,046 | $4,566 | $486 | $1,006 | |
Melbourne | $806,144 | $644,915 | $2,545 | $2,892 | $3,264 | $348 | $719 | |
Brisbane | $770,808 | $616,646 | $2,433 | $2,766 | $3,121 | $332 | $687 | |
Adelaide | $619,819 | $495,855 | $1,957 | $2,224 | $2,509 | $267 | $553 | |
Perth | $552,128 | $441,702 | $1,743 | $1,981 | $2,235 | $238 | $492 | |
Hobart | $735,425 | $588,340 | $2,322 | $2,639 | $2,978 | $317 | $656 | |
Darwin | $501,182 | $400,945 | $1,582 | $1,798 | $2,029 | $216 | $447 | |
Canberra | $947,309 | $757,847 | $2,990 | $3,399 | $3,835 | $408 | $845 | |
Combined capitals | $827,410 | $661,928 | $2,612 | $2,969 | $3,350 | $357 | $738 | |
National | $748,635 | $598,908 | $2,363 | $2,686 | $3,031 | $323 | $668 | |
Source: CoreLogic. Scenario assumes a current variable mortgage rate of 2.49%, monthly P&I loan repayments over 30 years. |