How the super-sized interest rate rise could affect homebuyer and borrowers

Reserve Bank of Australia governor Philip Lowe says the COVID-19 emergency is over, paving the way for thick and fast interest rate rises to get surging inflation under control. 

The RBA increased the official cash rate by a larger-than-usual 50 basis points in June, taking the official cash rate to 0.85% and back to pre-pandemic levels.

Speaking for the first time since the interest rate decision last Tuesday, Mr Lowe told the ABC’s 7.30 program there was still have a long way to go with inflation projected to reach 7% by the end of the year.

“At the moment it’s 5% and by the end of the year I expect inflation to get to 7%,” he said.

“That’s a very high number and we need to be able to chart a course back to 2% to 3% inflation. I’m confident we can do that but it’s going to take time.”

Mr Lowe said it was reasonable to expect the cash rate would reach 2.5% at some point.

“How fast we get to 2.5%, and indeed whether we get to 2.5%, is going to be determined by events,” he said.

“But what we’ve got to do is make sure inflation comes back to 2 to 3% and it’s unclear at the moment how far interest rates will need to go up to get that.

“We had emergency settings during the pandemic – that was the right thing to do – but the emergency is over and it’s time to remove the emergency settings and move to more normal settings for monetary policy.”

PropTrack economist Paul Ryan said the larger-than-expected rate hike in June signalled the RBA will increase rates quickly to get inflation under control, and would continue to flow through to the property market.

“This higher-than-expected increase in the cash rate by the RBA will be taken cautiously by buyers and will likely impact sentiment,” Mr Ryan said.

The rising cost of living

This latest rate hike – and forecasts of more to come – add further pressure to borrowers at a time when living costs are also on the rise.

The cost of living, as measured by the Consumer Price Index (CPI), rose by 5.1% in the 12 months to the March quarter.

Mr Lowe said higher-than-expected inflation was due to a combination of international and domestic pressures.

“Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation,” Mr Lowe said in a statement following the June interest rate decision.

“But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices. The floods earlier this year have also affected some prices.”

And all of the costs are adding up.

Commsec estimates the average family is spending $275.66 a month to fill up the car with petrol, an extra $54 a month compared with the start of the year.

Data provided to Smartline by grocery price tracking app Frugl shows the cost of many pantry items have skyrocketed more than 20% this year. It found cooking oils are up 10-30% in price due to global shortages in palm oil and soybeans, while instant coffee has surged as much as 50%.

Flash flooding along Australia’s east coast has also hit fresh fruit and vegetable prices, such as lettuce and tomatoes.

In contrast, wages rose by just 2.4% in the 12 months to March, data by the Australian Bureau of Statistics showed.

But in welcome news for Australia’s lowest paid workers, the Fair Work Commission on Wednesday announced the minimum wage would rise 5.2% to reflect the higher living costs. It equates to an extra $40 a week.

How will rate rises affect mortgage rates?

Higher interest rates mean borrowers face bigger loan repayments, as lenders pass on the higher costs to customers with a variable-rate home loan.

For existing mortgage holders, this is an added expense that has to be absorbed.

Analysis conducted with the Smartline home loan repayment calculator shows a borrower with a $500,000 mortgage, who had an average interest rate of 2.86%, according to RBA April figures, prior to the rate hikes, would now be facing an extra $206 per month in interest repayments if their lender passes on the full combined rate increase of 0.75%.

In this calculation, the borrower is an owner occupier paying principal and interest with 30 years remaining on their loan. The calculation does not factor in loan fees and charges, or any principal paid down over time.

For prospective buyers wanting to get a new loan, a higher rate typically reduces their borrowing capacity since higher repayments will affect their ability to service the loan.

How will rate rises affect property prices?

When borrowers are unable to borrow as much, they can’t pay as much for a property. This reduces demand and has a dampening effect on prices.

In the Reserve Bank’s latest Financial Stability Review, it was estimated that a 2% increase in interest rates could reduce real dwelling prices by 15% over two years.

Economists at the major banks also predict double-digit price falls nationally, with Westpac forecasting a 14% peak-to-trough decline by 2024.

Mr Ryan said price growth is falling because people have expectations of sharply higher interest rates later in the year.

“There’s a lot of uncertainty for price growth because of higher interest rates, so people are bidding less aggressively than they had been last year, and we’re likely to see that continue,” he said.

“Housing price growth has [already] slowed significantly. More interest rate increases are expected, but just how high interest rates will be at the end of the year is a key source of uncertainty for the housing market.

“I think it’s worth noting that prices are still up 35% nationally since the start of the pandemic, so the small falls or the slower growth that we’re seeing now isn’t the bigger picture for [sellers].

“Despite conditions, I think that is going to continue to support seller activity for some time.”

Resource: smartline.com.au