Interest rates to rise early, but now high will they climb?

The Reserve Bank last lifted its official interest rate in 2010. When it happens again, the pain may be less than you think.

For many months, we’ve been consistently told the Reserve Bank of Australia won’t raise its official interest rate until 2024.

Much of that consistent telling has come from the RBA itself, but now it’s backed off a bit and a lot of money in financial markets is betting on rate rises in 2022.

Some economists have tipped at least two rises by the end of next year, which won’t be welcome news for the millions of Aussies with large home loans – particularly those who’ve bought at high prices in recent years.

We can blame rising inflation for the rushed timeline for moving the official cash rate, which hasn’t budged since the RBA cut it to a record low of 0.1 per cent in November 2020.

When the rate rises come, they will be a worrying new experience for many borrowers, given the last time it happened was November 2010.

The RBA uses its cash rate as a tool to try to keep inflation between 2 and 3 per cent – a level it says is just right for sustainable economic growth. In theory, cutting rates should stimulate growth and inflation, while rate rises put the brakes on.

That hasn’t worked too well in recent years as persistent low inflation was driven even lower by the pandemic, but the global economic recovery from Covid-19 is injecting inflation into economies everywhere. We’ve already seen surging oil prices, which can push up the cost of everything from petrol and groceries to Christmas goods and toys.

Interest rate rises by the RBA are likely to be limited to what average borrowers can afford.

While Aussie inflation is still at the low end of the RBA’s 2-3 per cent target band, the US annual inflation rate has been hitting 13-year highs near 5.5 per cent. And the US economy shapes much of the world economy.

The latest Australian CPI data was stronger than expected, which is why we are seeing fresh forecasts of RBA rate rises coming sooner.

While this may be uncomfortable for many borrowers, particularly debt-laden first home buyers and investors, the good news is most Aussies shouldn’t expect interest rates to rise higher than our personal borrowing capacity allows.

This month a rule change from banking regulator APRA increased the minimum interest rate stress test banks must use when assessing people’s ability to service their home loan. It’s climbed from 2.5 to 3 per cent, which means when you apply for a mortgage a bank will only lend you the money if it judges you could still afford repayments 3 per cent higher than today.

Many economists and analysts believe a 3 per cent rate rise from current levels would be nasty for house prices and the economy because people today have much more debt than they did back when rates were a lot higher.

It’s a global issue. Munro Partners chief investment officer Nick Griffin says once there’s more debt in the world, it’s harder for interest rates to go up. He says a 3 per cent cash rate would probably lead to a housing crisis in Australia.

And if people start suffering financially because of rate rises, our economy will struggle, inflation will be weak, and you can expect those rates to start coming down again.