Why interest rates won’t increase to mortgage-killer levels

Home loan interest rates will continue climbing in June, but don’t expect them to hit the levels some are forecasting.

In less than two weeks, the Reserve Bank of Australia is likely to increase mortgage interest rates again.

It may be by 0.25 percentage points, it may be by 0.4 percentage points, and whatever it is, it won’t be pleasant for borrowers already grappling with this month’s RBA rate rise from 0.1 to 0.35 per cent.

On June 7 the RBA board meets again, and surging inflation means it is expected to keep its foot on the rate rise pedal in the months ahead.

However, forecasts by financial markets, some economists and even RBA modelling of its rate reaching 2.5 per cent in 2023 make me think of Aussie housing icon Darryl Kerrigan’s immortal words: “tell ‘em they’re dreamin’!”

One rate rise of 0.25 per cent was a shock to borrowers’ systems. Two or three rises will put many homeowners into a financial emergency. But 10 of them would mean death to many mortgages.

And that is why it won’t happen.

The RBA uses its official interest rate – known as the cash rate – as a lever to speed up or slow down inflation and the economy.

It had been cutting rates for years because inflation was persistently below the 2-3 per cent target range it sees as ideal for sustained economic growth.

Interest bills are going to get bigger, faster, but don’t believe the doomsayers.

But now that inflation has spiked in Australia to 5.1 per cent, driven higher by global supply chain problems and surging oil prices, the RBA is lifting rates to put the squeeze on household spending.

Digital Finance Analytics principal Martin North measures mortgage stress across all Aussie postcodes and says 40 per cent of home loan households are already under stress – where their expenses exceed their income.

This could rise to 50 per cent next year, he says, adding that if rates rise 2 per cent average mortgage repayments rise 30 per cent.

Most households simply can’t afford a rate rise hit approaching 2.5 per cent, so their reaction will be to stop spending. When people stop spending, shops generally stop putting prices up, so inflation growth slows.

While inflation’s at 5 per cent now, and tipped to go to about 6 per cent, it will have to continue rising by that level to prompt ongoing rate rises next year and beyond.

Economists think that global supply chain bottlenecks will be overcome, although Russia’s war on Ukraine is causing havoc with commodity prices, especially wheat and energy.

And the tough talk in early May of 2.5 per cent rises already seems to be weakening as consumer sentiment sinks.

The boss of Australia’s biggest bank, the Commonwealth Bank, has forecast the RBA rate to go to 1.6 per cent, while REA Group senior economist Eleanor Creagh has said “I don’t think the RBA will be able to be anywhere near as aggressive as some are forecasting”.

Hopefully for households they are right, and the RBA and many forecasters are wrong.

Remember that until late last year the RBA was telling mortgage customers that rates would stay on hold until 2024. Now that was dreamin’.