Showing posts with label interest rates. Show all posts
Showing posts with label interest rates. Show all posts

Wednesday 9 November 2022

Australia is seeing mortgage stress and other cost-of-living pressures rise, but we can avoid the financial impact being felt in the UK and US, says a UNSW Business School real estate expert


A perspective on the national economy, inflationary pressures, interest rates, house prices, household budgets and cost of living......





UNSW, media release, 7 November 2022:





What happens to the economy if you can't pay your home loan?


Australia is seeing mortgage stress and other cost-of-living pressures rise, but we can avoid the financial impact being felt in the UK and US, says a UNSW Business School real estate expert.


For economists – and indeed, anyone else with an interest on how much they spend at the supermarket – cost-of-living and housing prices have been hot topics in 2022. The Reserve Bank of Australia (RBA) has been trying to combat rising inflation with interest rate raises (read how that works here).


The latest rise was announced by the RBA last week on November 1, with the official cash rate rising to 2.85 per cent.


This process has contributed to a fall in house prices in some areas, as well as fears from mortgage holders that they won't be able to make payments on the now larger amounts.


“Australians have been fortunate to see sustained house price growth for a while now,” says economist and expert in real estate markets, Dr Kristle Romero Cortés Associate Professor in the School of Banking & Finance, UNSW Business School. “But they need to know, house prices can come down too.”


But while data from the Domain Group (shares of which are majority owned by Nine Media) might have recently shown the sharpest quarterly decline in house prices since 1994 across the country’s biggest capital cities, Dr Romero Cortés isn’t unduly concerned about house price falls.


“Commentary on the housing market is quite sensationalised in the media.”


But when it comes to not being able to pay the mortgage, and the impact higher loan repayments might have on the economy? That’s a bit more complicated to predict.


Why Australia may not follow other countries into financial disaster


Australians only have to look over to the United Kingdom to feel nervous when witnessing the impact of high inflation and interest rates on the economy and the day-to-day lives of financial situation of its citizens.


Like Australia, the UK’s central bank (the Bank of England) has introduced a series of interest rate hikes that have had a limited effect. Unlike Australia, the UK economy is still reeling from Brexit, plus a post-pandemic recovery, high inflation and energy costs, and levels of wage stagnation that have seen various sections of the working population strike.


The country has also just experienced the effects of a disastrous set of economic policies and extensive tax cuts for the wealthy implemented by Liz Truss as prime minister, which would have put money into in an already inflated economy (where the idea is to usually ‘cool’ things by encouraging people not to spend).


This spooked the financial markets to such a degree that investors quickly sold off British assets, including government bonds. The value of the pound plunged, forced the Bank of England to take an unprecedented step and pledge 65 billion pounds worth of bonds to stop pension funds from failing and stabilise the market … and caused Liz Truss to resign after just 44 days.


For the average Briton, this situation has led to a greater threat of recession: something which could lead to loss of jobs, higher unemployment, higher inequality, wage growth that is too low to match price increases, and issues meeting costs, such as regular mortgage payments that have already risen because of interest rate hikes.


But does the UK situation foreshadow D-R-A-M-A for the Australia’s own economy and housing market? Dr Romero Cortés says no – for several reasons.


Australians are fans of variable rate loans - unlike in the UK


As well as not experiencing a Brexit-like crash or an energy price crunch to the same degree, a big point of difference is that Australians are more likely to have opted for the more flexible variable rate mortgages, than in the UK, where homeowners are more likely to have picked fixed rate mortgage.


In the UK, 74 per cent of homeowners have a fixed rate mortgage for their home loans, and 96 per cent have chosen this option since 2019, according to data from UK-based trade association, UK Finance. AMP Capital data shows that Australia has a higher share of mortgage holders with variable rate mortgages. Just 10-15 per cent picked fixed rates before 2020 (although this rose to 40 per cent in 2020-2021).


While variable rate mortgages can be a great option when interest rates are low in the short-term, fixed rate mortgages can be more predictable over the long-term, as they are less impacted by interest rate rises that can raise overall home loan repayments.


“What we see in the US or Europe is not necessarily what we will see here,” Dr Romero Cortés says. “The US Federal Reserve (Fed) or the Bank of England are also effectively trying to slow down the economy, but when they raise their rates, they can't reach a large portion of homeowners that have a 30-year fixed rate mortgage.


“The Fed and the Bank of England can raise cash rates all they want – they are not reaching these homeowners.


“In Australia, our increases from the RBA pass through the banks almost instantaneously to the consumers,” she explains. “There is a slight delay because banks want to give borrowers as much time as possible to budget in an increase, but that rate does flow through almost automatically in a way that's much faster here than you'll see in countries like the US and UK.”


This means, faster possible cooling impacts on the economy with the RBA puts interest rate hikes in place.


Another big factor is that the big four Australian banks are highly capitalised.


“They are flush with cash,” explains Dr Romero Cortés. “I study the financial network in Australia, and it is very sound. We won’t see the kind of crisis that we saw in the US in 2008, where the banks were holding assets that they didn't understand the underlying worth of.”


What does that mean for mortgage stress and the Australian economy?


Dr Romero Cortés say that while lifting of interest rates might mean Australia will see mortgage stress rise faster than in other places, it is this situation that helps the RBA prevent the economy from “running red hot” and collapsing in on itself.


“Like any central bank, the RBA wants to ensure price stability, and they will do whatever it takes to prevent us from losing this. They don’t want consumables like bread and eggs to suddenly be seven times as much the next day. If that happens people will revolt, effectively.


“We're nowhere near there. But that's why we don't want to get anywhere near there. So, the RBA stay very much on top of this, and their role is to keep this issue as front and centre of the Australian public for as long as they need, so they are more cautious with their spending over a longer period of time.”


It’s in this way that the RBA plays a psychological stabilising role, not just a financial one.


“You know, ‘Okay, the RBA is on this: so, I don't need to freak out’,” says Dr Romero Cortés. “Because if you as a member of the financial public start freaking out, you’re more likely to make poor financial decisions which have more of a domino effect on the wider economy.”


Having said that, there is a limit to how much financial stress homeowners can undergo.


"There could be a point where homeowners and others can't withstand the raising of monthly repayments any longer,” she says. “This is not yet the case.


“Long term, you would expect some sort of horizon where things settle around 4 or 5 per cent cash rate. Australia is highly leveraged (meaning it has an on average high level of debt to equity), so more than that would be difficult to sustain.”


Banks don’t want to see mortgage defaults


At the end of the day, lenders don’t want homeowners to default on loans or to proceed with a repossession. It’s costly, in time, effort and capital for them, says Dr Romero Cortés. They would much rather work with the borrower before they get to that point of extreme financial difficulties.


“A homeowner in financial stress would contact your bank, who would require some documentation of financial hardship, and then would work with you either in a payment plan or deferral plan, refinancing or making interest-only payments.”


Remember: you're not getting out of it. You still pay it, the interest is still accruing, and it could lengthen the loan term. All this means that borrowers are going to consume less in other places, and therefore is supposed to lead to a ‘cooling’ of the economy.


What happens if cost of living doesn’t come down?



But if living here gets too hard and expensive with inflation or higher mortgage repayments, you could see Australia reputation as ‘a good place to live’ take a hit, pushing down the number of people who want to live here, and putting further pressure on an already tight labour market, says Dr Romero Cortés.


For example, a portion of all the Australians with overseas heritage might decide Australia is too hard and expensive to live in and move to their other country of citizenship. That’s when it might start to get uncomfortable.


"Australia has an economy that's built up by people wanting to come to Australia, and we’re constantly growing in that fashion,” explains Dr Romero Cortés. “There's demand for housing, education, and we currently have people willing to come here.


“So, the government can say whatever they want about the RBA [and their decision to raise rates] so they will get voted in again. But the RBA doesn’t have a choice: one family defaulting on their mortgage, compared to everyone not being able to afford bread, is what they are envisioning.”


Does all this mean house prices will come down more?


Higher mortgage repayments could pressure homeowners to accept lower sale prices than they might have expected from their property, investment or otherwise; nudging down overall prices on the property market over a period of time, as well as the occasional ‘fire sale’.


Are you going to see a massive crash of house prices where you see a Bondi four-bedder going for $500,000? No.


“But we could see a small depression in prices where 5 to 10 per cent of the price is cut. Even if you cut off 10 per cent from a $2 million home, that's $200,000 less. This means unless they have to, sellers are not going to want to sell.”


All this means it is true you're going see some very high mortgage payments and additional cost of living pressures as homeowners prioritise their mortgage repayments, Dr Romero Cortés points out.


“It’s also true that politicians (who are complaining about the RBA’s approach) may be among those who own a lot of investment properties themselves.”


Dr Kristle Romero Cortés is an Associate Professor in the School of Banking & Finance in the Business School at UNSW Sydney, an expert in real estate economics and formerly worked at the Federal Reserve Bank of Cleveland.


Saturday 17 September 2022

Tweet of the Week


 

Friday 10 June 2022

Australia's Reserve Bank signals that inflation is expected to increase beyond the 5.1% rise recorded for the twelve months to March Quarter 2022 - 5 weeks after initially raising its cash rate target the Bank raised the rate for a second time on 7 June 2022

 

On 3 May 2022 the Reserve Bank announced that due to a stronger than expected rise in the inflation rate, measures were being undertaken to reduce inflationary pressure. 


Put simply, monetary policy indicated a need to drive the current inflation rate from 5.1% down to somewhere between 2-3% to keep basic cost of living increases within manageable limits and the national economy stable.


In order to begin this process the Board decided to increase the cash rate target by 25 basis points to 35 basis points. It also increased the interest rate on Exchange Settlement balances from zero percent to 25 basis points.


This translated into a cash rate of 0.34% and an exchange settlement balance interest rate of 0.25%.


On 7 May the Reserve Bank moved again - raising the cash rate to 0.85% and the exchange settlement balance interest rate to 0.75%.


If inflation continues to rise in the second half of this year it is possible that the Reserve Bank will increase the cash rate target to est. 1.25% by the end of December 2022. There is some speculation in business/financial media that the cash rate target might go as high as 2.5% sometime in 2023 before it begins to fall.


Commercial banks will likely be reassessing their lending rates in the coming weeks. The four big banks - Westpac, CBA, ANZ and NAB - have already responded with variable home loans increasing by 0.5%. That increase comes into effect from 17 June (CBA, ANZ, NAB) and 21 June 2022 (Westpac). 


By way of example, this increase is likely to add around $115 per month on a $450,000 home loan where the homeowner is making a scheduled principal and interest payment. 


~~~~~~~~~~~~~~~~~~~~


Reserve Bank of Australia


Media Release

Statement by Philip Lowe, Governor: Monetary Policy Decision

Number 2022-14

Date 7 June 2022


At its meeting today, the Board decided to increase the cash rate target by 50 basis points to 85 basis points. It also increased the interest rate on Exchange Settlement balances by 50 basis points to 75 basis points.


Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected. Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation. But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices. The floods earlier this year have also affected some prices.


Inflation is expected to increase further, but then decline back towards the 2–3 per cent range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago. As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today's increase in interest rates will assist with the return of inflation to target over time.


The Australian economy is resilient, growing by 0.8 per cent in the March quarter and 3.3 per cent over the year. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed. Macroeconomic policy settings are supportive of growth and national income is being boosted by higher commodity prices. The terms of trade are at a record high.


The labour market is also strong. Employment has grown significantly and the unemployment rate is 3.9 per cent, which is the lowest rate in almost 50 years. Job vacancies and job ads are at high levels and a further decline in unemployment and underemployment is expected. The Bank's business liaison program continues to point to a lift in wages growth from the low rates of recent years as firms compete for staff in a tight labour market.


One source of uncertainty about the economic outlook is how household spending evolves, given the increasing pressure on Australian households' budgets from higher inflation. Interest rates are also increasing. Housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic, supporting household wealth and spending. The household saving rate also remains higher than it was before the pandemic and many households have built up large financial buffers. While the central scenario is for strong household consumption growth this year, the Board will be paying close attention to these various influences on consumption as it assesses the appropriate setting of monetary policy.


The Board will also be paying close attention to the global outlook, which remains clouded by the war in Ukraine and its effect on the prices for energy and agricultural commodities. Real household incomes are under pressure in many economies and financial conditions are tightening, as central banks withdraw monetary policy support in response to broad-based inflation. There are also ongoing uncertainties related to COVID, especially in China.


Today's increase in interest rates by the Board is a further step in the withdrawal of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed. Given the current inflation pressures in the economy, and the still very low level of interest rates, the Board decided to move by 50 basis points today. The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board's assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. [my yellow highlighting]


Wednesday 3 July 2019

Well, wouldn't you know it!


Yesterday the Reserve Bank of Australia cut the cash rate from 1.25% to 1%. However, the Commonwealth Bank, The National Australia Bank and Westpac announced they will not be passing on the full benefit of the interest cut rate to all of their home loan customers. Meanwhile, ANZ Bank said it will pass on the cut in full.

Let's go back to June when the RBA cut the cash rate from 1.5% to 1.25%. The Commonwealth Bank, the National Bank and Westpac passed on the full cut but the ANZ Bank didn't.


Who's having a lend of who?

This observer reckons the Big Four are having a lend of us all.