Prepare for interest rate pain after the US kicked things off

While the US has flagged six more interest rate hikes this year alone to combat inflation, Australia is unlikely to do as much. Picture: Spencer Platt / Getty Images /AFP

Prepare for pain. The best way to illustrate the looming interest rate rise discomfort is to translate what the US Federal Reserve’s proposals would mean in Australia.

The US interest rate increases that were flagged overnight would see Australian mortgage rates climb by at least 1.75 per cent by the end of the year and by the end of next year they will have risen by 2.5 per cent.

Such an interest rate rise would devastate segments of the Australian housing market – both new and existing dwellings – and cause considerable bad debts in banks. Australians for the most part have borrowed on a flexible rate basis and even those who locked in rates did so for a relatively short time. Unlike the US, we receive the full force of rate rises.

American home buyers are able to lock in interest rates for up to 30 years so, unlike Australia, the higher US rates do not substantially impact past borrowings.

Because our mortgage suffering is set to be greater than the US, I don’t think the Reserve Bank of Australia will lift interest rates as high as what the US Federal Reserve is now proposing. In addition, Australia’s inflation rate is lower than the US.

But hanging over everyone’s head are the 10-year bond rates.

Around the middle of last year, both the US and Australian 10-year bond rates were around the 1.1 per cent mark. The US bond rate has risen to 2.2 per cent which has caused alarm around the world because it’s effectively doubled.

But the Australian 10-year rate has risen further to 2.5 per cent. Given our huge Federal and state government debts, and heavy borrowing by consumers, the world is demanding higher returns when lending to Australia.

Higher Australian bond rates are going to increase the cost of bank borrowing so, even if the Reserve Bank does not match the US official rates, mortgage rates will rise faster that the rates set by the RBA.

Australia is looking at a sharp rise in migration and students. They will need housing and there are no substantial accommodation surpluses, so rents are set to rise and that will accelerate in the states that have gone too far in tenant protection which forces landlords to lift rents to cover increased risks.

Fortunately we do have ways to curb the impact on new developments. About half the cost of a new dwelling comprises stamp duty, GST and the huge armies of bureaucrats in multiple bodies that devote their lives to delaying decisions and increasing the cost of housing. Those armies will need to be cut back substantially so that approvals and rejections of new developments are made simple with straightforward rules.

The bureaucrats in local and state governments will fight hard to keep their jobs so it will take community pain for the councils and state governments to act. States are so debt ridden that they cant afford to reduce GST or stamp duty but again there will be great pressure for such action.

And behind those simple figures are substantial losses for those who invested at low rates in government and corporate bonds, as well as the considerable suffering for those that have over borrowed. But higher bank deposit rates will boost incomes of older people.

Australian banks tell us that their lending portfolios are in good shape because a great many Australians have moved ahead in their repayments. But those who have borrowed more recently don’t have that luxury. Their ranks are dominated by migrants who came to Australia several years ago.

Among the areas that will suffer the most are some of the fast growing regional towns where the building and borrowing has been frenetic.

Recent figures released by Digital Finance Analytics revealed that 22,000 of the 135,000 households in the Geelong region were suffering from mortgage stress in January 2022. That’s up sharply on the level of a year earlier. (Mortgage rate stress is defined as those paying more than 30 per cent of their household income on mortgage repayments.)

My guess is that the outer suburbs of Melbourne, Sydney and other capitals will also have similar experiences.

To the extent that inflation was caused by supply chain problems, it can be overcome without great pain. But in both the US and Australia, underlying costs have increased so it becomes an extremely painful process to force those costs and prices lower by reducing economic activity.

But masked by all the attention on interest rates was a rise in copper and iron ore prices caused in part by China’s announcement that it was planning to stimulate its economy. That’s good news for Australia.