The Reserve Bank talks of a narrow path in getting the inflation under control without sinking the economy, but the central bank’s board also knows its reputation is treading a fine line.
In delivering its third back to back interest rate hike of 50 basis points to a new target of 1.85 per cent, the RBA has signalled it is about to turn down the intensity ever so slightly.
This is relief for an economy that is only now just coming to terms with the most aggressive interest rate hiking cycle in nearly three decades. More rate rises are coming, but expect the central bank to start moving in 25 basis point increments rather than the super-sized hits we’ve seen until now.
This might be of little comfort to some homeowners with the market still tipping the cash rate will peak at above 3.2 per cent. This has real world implications, which has finally started to catch the central bank’s attention.
Top-rated banking analyst Jon Mott of Barrenjoey warns that this could be the first bad debt cycle in 50 years that is led by households rather than businesses. And the big four banks are most exposed to this.
Mott estimates there are $250bn of mortgages “at risk” given these were taken out by customers who borrowed at or near their maximum capacity through Covid.
“If the cash rate rises to around 3 per cent a large proportion of these customers are likely to become delinquent,” Mott says. Especially if the cash rate doesn’t start to fall by late 2023.
The upcoming bank reporting season will be critical for signs of stress in the “tail”, that is the last 5 to 10 per cent of borrowers that might be struggling.
Mott points out the cocktail of borrowing events including households who used record low interest rates, the former government’s pressure to ease responsible lending checks and also the RBA’s assurances through the pandemic that rates will remain very low until 2024.
These customers are likely to be most exposed to the rapid rising rate environment.
“For the first time in several decades we are likely to see a wave of fully employed borrowers falling into delinquency as they simply can’t make ends meet,” Mott warns.
S&P Ratings which tracks the health of mortgages says it expects to start seeing the impact of higher interest rates come through during the current September quarter. The pressures are likely to start showing up first through a decline in consumer spending as homeowners prioritise mortgage repayments over other spending.
Moderation
After front loading rate hikes, the great moderation is starting to play out globally with the powerful US Federal Reserve also hinting at slowing the pace of rate hikes there after recently pushing through a 75 basis point hike. This is also the case here.
RBA Governor Philip Lowe – who this week found his lunch run on the way to work, splashed on the front of Sydney’s Daily Telegraph – says while rates need to rise further to tame inflation, it is important to do this “while keeping the economy on an even keel”.
In other words putting out the inflation fire shouldn’t come at all costs including collapsing the entire economy.
Where the central bank is clearly starting to get nervous is the medium term outlook for Australia’s economic growth. This comes on the back of the Treasurer’s downbeat address to Parliament last week where the government downgraded its own forecasts for growth from next year.
Lowe added the point that more rate rises are still to come in order to “normalise” the cash rate but it won’t be “on a pre-set path”.
With the dollar dipping and long term bond yields falling on the RBA’s comments the money markets were clearly left with the impression that the central bank is easing ever so slightly in its rush to raise rates.
On Tuesday RBA issued some new forecasts following Tuesday’s rate hike and while it revised peak inflation up to 7.75 per cent from 5.9 per cent previously, it sharply revised down its outlook for growth.
The RBA now expects Australia’s GDP growth of 3.25 per cent over 2022 where previously it was 4.25 per cent. It then sees the economy slowing to 1.75 per cent over 2023, downgrading from 2 per cent previously. These new figures are slightly more bearish than Chalmers’ Treasury which expects the economy to slow to 2 per cent. The RBA is tipping the unemployment rate to start rising during 2023 as the economy slows.
This is the balancing act. Inflation on its own forecasts won’t be tamed until well into 2024 but the economy will clearly be vulnerable to a slowdown.
As HSBC Australia chief economist Paul Bloxham points out the RBA “tends not to increase” its cash rate when the unemployment rate is rising. If this is the case it will imply that “rates are unlikely to rise further next year,” he says.
Still for now rates are still going up. The debate has now started to shift how fast and when they will peak. Capital Economics’ Marcel Thieliant is still tipping the central bank to lift the cash rate to 3.6 per cent by early next year, which means a constant rate of increases over the next few months. Money markets are clustered are rates topping out at 3.6 per cent.
However, Thieliant notes “it’s clear that this aggressive tightening is starting to take its toll on the economy”.
“With house prices now falling at the fastest pace in four decades, we expect GDP growth to slow more sharply next year than the RBA anticipates”.
There is some relief on the horizon, he says. This time next year interest rates are expected to start falling again. It’s just a matter if we can all get there in one piece.
johnstone@theaustralian.com.au
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