Australian dollar at risk if RBA doesn’t tame inflation

Despite the Reserve Bank’s interest rate rise pause, it's time to face the blunt facts, even though the news is not pleasant.

The cost of doing business in Australia is still rising sharply, and we have a government where increased productivity is simply not on the agenda as they seek to further lift business costs via industrial relations legislation.

And as those costs are passed on by larger enterprises the resulting inflation will likely cause interest rates to rise again creating mind-blowing mortgage stress numbers.

Roy Morgan Research estimates that 1.4 million mortgage holders or 28.8 per cent of the total are at risk of mortgage stress – the highest per cent percentage since September 2011.

As I will explain below, bank shareholders need to understand that if mortgage rates rise further, their boards and top managers will come under an immense community pressure that will almost certainly impact the bottom line. CBA and Westpac chief executives will be in the front line.

The latest round of enterprise agreements show an average wage rises of 3.7 per cent with plenty of agreements at higher levels including inflation protection. NSW health care workers have rejected 4.5 per cent increase including superannuation and appear to want above 6 per cent.

If wage thrusts like NSW Health are successful, the nation must either find a way of living with inflation in the vicinity of at least four per cent or the RBA must throttle the economy, boosting unemployment sharply and creating a severe recession in our capital cities.

In its July decision, the RBA hesitated before embarking on a much tougher set of decisions.

Unless there is a change in world central bank sentiment, no matter who is in charge after Philip Lowe’s term as governor ends in September, our RBA will have to keep interest rates high if inflation remains high or risk having the Australian dollar trashed so boosting inflation further.

In recent months, Sweden toyed with the idea of not matching European interest rates and traders hit its currency, sending it down 5 per cent against the Euro, but the selling steadied when Swedish rates began to match Europe.

This week my colleague James Kirby predicted that if there are two more interest rate rises – as most economists predict – and mortgage rates are sent to 7 per cent then the current rally in house prices will be followed by a fall because buyers will not be able to afford the higher prices and some heavily mortgaged people will need to exit.

If Kirby is right, and there is a good chance he is, then this will create a totally different environment for banking in Australia.

If interest rates continue to climb, then house prices are set to fall again. Picture: Dan Peled/AAP Image

One of the reasons why house prices have withstood pressures of higher interest rates is that the cost of building new homes on an equivalent “bricks and mortar” basis is higher than existing dwellings. This gap can be reduced by state governments and local councils, whose teams of high-cost committees and bodies act without sufficient consideration to the costs that they impose on the cost of dwellings

But the gap won’t be easy to reduce because the army of subcontractors has been diminished by the builder collapses. Many have left the industry and others are now working on unionised infrastructure projects where the rewards for effort are much higher.

If mortgage rates rise to seven per cent and that will flow through into actual mortgage outlays in the final quarter of the year, so boosting mortgage stress to even greater levels. Any fall in house prices it will compound the situation.

A new cloud will descend on those banks who became overextended in mortgage loans, led by the Commonwealth Bank and Westpac. The ANZ wisely lost market share during the lending spree, and the NAB’s housing market exposure is lower than the other banks.

CBA CEO Matt Comyn and chairman Paul O'Malley. Picture: Luis Ascui/NCA NewsWire

All bank CEOs will face an entirely different set of circumstances to anything their predecessors have faced.

The way individual banks handle mortgage stress will be the focus of breakfast and current affairs television plus a massive social media exposure, This will make exercising bank powers in mortgage contracts very dangerous.

Day after day, “enormous” bank profits will be linked to any attempt to foreclose on mortgages. Banks and their CEO’s will be ravaged by the media if they start evicting people from homes, unless there has been particularly bad behaviour by mortgagee.

Banks will be forced to forgo principal payments and may need to reduce interest payments for parts of their mortgage book.

ALP government in Canberra and all mainland states will not have sympathy for banks. Nor will the media. Those who are under mortgage stress should be aware of their looming power and if they wish to exit the housing market at this point then so be it. Those who want to stay in the market should begin conversations with bank lender and regulatory authorities and document the conversations.

To date, Australian wage driven inflation has been moderated, partly because many companies some years ago entered into long term enterprise agreements offering wage increases that now look to be low. As they are replaced, increasingly the new agreements reflect a different set of wage expectations, which may spread around the nation.

Large enterprises and government bodies who are entering into these higher wage deals usually have market clout and the ability to pass on the costs.

While there are exceptions, it is the small to medium-sized operations that don’t have the ability to pass on higher costs that are set to struggle. They must find the capital to invest in labour-saving exercises.

Most banks and economists believe interest rates and inflation will fall next year. But if inflation stays around or above four per cent, then interest rates will not fall as quickly as is currently expected.