Australia faces lower dollar, money outflows if rates kept artificially low due to vulnerable housing market: Robert Gottliebsen

Australia faces a weaker dollar and money outflows if interest rates are kept artificially low because of the vulnerable housing market. Picture: Paul Braven/AAP Image

All of us want to join world share markets in celebrating a possible end to the Ukrainian conflict. But in the light of the federal budget Australians are banking on something more – an end to the global inflationary spiral.

The Australian Treasury and both major political parties are basing their policies on the assumption that the global inflation breakout was an “aberration” and that the world will come back to a situation closer to what we have been enjoying in recent years.

No other developed nation in the world has more at stake in the “aberration” assumption becoming a fact than Australia.

There is no other nation in the world where a small rise in mortgage interest rates of between 2.5 and 3 per cent would cause a recession with sharply falling property and share values. Yesterday, I devoted my budgetary commentary to the fact that in the Australian short term bond market, global institutions are alerting us to the risks we are taking. And we needed that alert.

Overnight, as I thought more deeply about the 1,000-plus page budget documents I realised that, as far as I could see, there was no mention (certainly no highlighting) of the very large risks facing Australia if the current global inflationary breakouts are not an “aberration”. Instead the world moves to a higher inflation/ higher interest rate environment as the new “normal”.

There is no other nation in the world that has allowed its dwelling market to be so vulnerable to a small change in the global inflationary and interest rate outlook

A significant chunk of Australian homeowners are highly leveraged because our Reserve Bank assured them that interest rates would not rise until 2024; our mortgage rates move with the market; we set rules that encouraged banks to divert money from business lending to dwellings and to lend large sums on mortgages.

This naturally ballooned the price of houses and to make sure new home buyers were borrowed to the eyeballs our state and local governments increased the price of new cottages or apartments by a further 40 or 50 per cent via taxes and outrageous bureaucratic delays and confusion.

This means that people who have borrowed large sums in recent years to buy a dwelling are very vulnerable to small interest rate rises because of their high leverage. The Commonwealth Bank estimates that the country can handle an interest rate rise of between 1.25 and 1.5 per cent.

But if the interest rate rises advance to 2.5 per cent – let alone the 3 per cent foreshadowed in the bond market — then the economy will suffer a severe shock. Commonwealth Bank economists Martin Whetton and Gareth Aird say such a rate rise would be “deeply contractionary”.

The Australian treasury estimates that while our consumer price index will jump to 4.25 per cent in the current financial year, in 2022-23 it will fall to 3 per cent and then to 2.75 per cent – ie back to what might be called “normal”.

Those small CPI increases would simply not be possible if China, the US and the rest of the world moved onto an inflationary level that is significantly higher. Remember the US is currently experiencing an inflation rate of 8 per cent and without much higher interest rates the US inflation rate will go into double figures.

Here in Australia, the ALP will campaign in the election for higher wages.

Last week’s commentary under the heading “Albo faces challenges like Whitlam in 1972”, I pointed out that to accelerate the momentum of the wage rise ball the Health Services Union and the Australian Nursing and Midwifery Federation have asked the Fair Work Commission for pay rises of 25 per cent for more than 200,000 workers, arguing pay rates in aged care don’t meet the Fair Work Act’s requirement for a “safety net of fair minimum wages”.

Whitlam style, Albanese says he will make a submission to Fair Work supporting an increase in pay for aged care workers if he wins the election. He does not specify an amount.

If the union has a major win then big wages rises will spread through the nation. If that is combined with high global inflation then you can forget those treasury CPI estimates which are based on a wage increases of around 3.25 per cent.

And if Australia keeps its interest rates artificially low because of our vulnerable housing market (as is likely) then we will head into a world of a lower dollar and money outflows.

This risk may not eventuate but needed to be discussed in the budget.

Any nation, government, enterprise or person who does not recognise the risks that they are taking faces great danger if events move in a way that is different to what they expect.