Why RBA rate hikes won’t break housing: Goldman Sachs

Goldman Sachs expects the Reserve Bank to lift the cash rate above 4 per cent. But it also says property owners can afford the hikes.

Goldman Sachs says the Reserve Bank of Australia can increase interest rates enough to lower inflation to an acceptable level without breaking the housing market and precipitating a recession.

Chief economist, Andrew Boak, expects the RBA to lift the cash rate to 4.1 per cent by May.

Higher interest rates are expected to cause a 15-20 per cent peak-to-trough fall in house prices.

However, it won’t leave too many borrowers with negative equity, Boak argues.

He sees Australia as relatively well-placed to avoid a recession, thanks to unusually large financial buffers and backstops to growth from a normalisation in services activity and population growth.

The RBA has increased the cash rate to 2.85 per cent from 0.1 per cent since May.

It’s one of its fastest rate hiking cycles on record, and the fastest since the early 1990s recession.

House prices have fallen six months in a row. The combined capital city average has fallen 6.5 per cent after rising 25.5 per cent from the Covid low in late 2020, according to CoreLogic.

The combined capital city average fell 1.2 per cent in October, or 14.4 per cent annualised.

Boak, a former RBA economist, concedes high inflation has “narrowed the path to a soft landing”, with downward pressure on the housing market and upward pressure on wages and inflation expectations now seen as the key risks.

The lagged impact of “unusually aggressive policy tightening” is a “key uncertainty.”

His “terminal rate” forecast for the cash rate – which drives mortgage rates – is at the upper end of the range of forecasts of market economists. Economists at CBA, UBS and AMP Capital expect it to peak at 3.1 per cent. The market has priced in a peak of about 3.85 per cent.

But Mr Boak sees the nation navigating further material rate increases and falls in house prices.

Relative to the US and UK, the Australian economy is more sensitive to housing cycles because housing wealth in Australia is over twice as big a share of the economy, and the shorter duration of mortgages here causes larger and earlier interest payment shocks when rates rise.

But notwithstanding a likely 15-20 per cent fall in house prices, Boak says relatively few mortgagees face negative equity or default, due to large financial buffers, the preceding large gains in house prices, a solid labour market, and eight years of macroprudential policy restraints.

Rising rates are a “headwind”, particularly for the 35 per cent of Australian mortgagees on course for a 40 per cent increase in their monthly repayment burden when they roll off low fixed rates to variable rates about 4 per cent higher over the coming year.

But while some mortgagees will face financial difficulty, Boak says “we would not be surprised to see Australia’s highly profitable, strongly provisioned and capitalised retail banks discreetly exercise forbearance to help manage these borrowers through the adjustment.”

He sees several reasons why the roll-off of fixed-rate mortgages will be manageable overall.

“Firstly, the fixed-rate roll-off will impact only around 7 per cent of Australian households by the end of 2023 — presenting an aggregate about 1.5 per cent headwind to household disposable income.

“In context, the latter is a small fraction of the 20 per cent of household disposable income in ‘excess savings’ accumulated by households over recent years,” Boak says.

“And secondly, the flip-side of rising interest rates is a boost to household incomes via higher interest receipts on the deposits that most Australians hold.”

Assuming a full pass-through of cash rate increases to the $1.5 trillion Australians hold in bank deposits, he sees a 4 per cent tailwind to household disposable income over the next couple of years.

Boak also sees a “manageable downswing” in Australian housing construction through 2023.

While expecting a further rise in insolvencies, his analysis is “not consistent with a painful bust that presents risk to financial stability”, particularly given the banking sector’s low exposure to developers — about 1 per cent of total bank exposure — and historically low leverage across listed developers.

He also sees a surge in migration and rising rents capping falls in the housing market over the longer term, and notes tentative evidence that house price declines have started to decelerate.

Higher interest payments and house price falls are expected to hit consumer spending and home building activity, but Mr Boak sees economic growth averaging 1.9 per cent in 2023 and 1.7 per cent in 2024 — below “potential” but not at recessionary levels normally associated with housing slumps.

Protracted sub-trend growth should see unemployment rise to more sustainable levels around 4.2 per cent by the end of 2024, after the jobless rate hit a five-decade low of 3.4 per cent in October.

However, Mr Boak sees “elevated” inflation and upside risks to wages growth through 2023.

And while expecting headline CPI inflation to fall from a late 2022 peak of 7.7 per cent on-year to 3.4 per cent in late 2022 on — as food, housing and tradables inflation cools — he sees core trimmed-mean inflation at 3.8 per cent on-year by the end of 2023. That’s well above the RBA’s 2-3 per cent target band.

“Despite an easing in pressures across global supply chains, the persistence of inflation in market services and residential rents suggests a somewhat slower deceleration in trimmed-mean inflation with an ongoing overshoot of the RBA’s 2-3 per cent target band until around mid-2024,” he says.

Policy settings will likely enter 2023 only just in line with the RBA’s “neutral” estimate of about 3 per cent, and there’s a risk of a wage-price spiral and/or breakout of inflation expectations, he says.