Mortgage repayments soar after 0.5 per cent interest rate hike

Mortgage repayments soar after 0.5 per cent interest rate hike

House prices across Australia’s five major capitals suffered their biggest monthly decline in nearly 40 years, according to data released this week.

Normally, falling house prices would be good news for home buyers. But with the Reserve Bank of Australia (RBA) on Tuesday hiking the official cash rate (OCR) another 0.5 per cent (to 1.85 per cent), buyers will find it increasingly difficult to enter the market.

As illustrated in the table below, the average discount variable mortgage rate will rise to 5.2 per cent after Tuesday’s decision, up from 3.45 per cent in April.

In turn, average monthly mortgage repayments will soar by 23 per cent from their April pre-tightening level.

For a household with a $500,000 mortgage, this represents a monthly increase in repayments of $514, whereas a household with a $1,000,000 mortgage will pay an extra $1,029 a month.

More mortgage pain to come

In the RBA’s monetary policy statement accompanying Tuesday’s rate hike, governor Phil Lowe stated that the 0.5 per cent increase was “a further step in the normalisation of monetary conditions in Australia” and that “the Board expects to take further steps in the process of normalising monetary conditions over the months ahead”.

This suggests that further interest rate hikes are on the cards over the remainder of 2022; although the RBA did stress that “is not on a preset path” and “will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market”.

Over recent weeks, both ANZ and Westpac raised their interest rate forecasts. They now expect the RBA to lift the OCR to 3 per cent by the end of the year, in line with the financial markets’ forecast.

If these forecasts come to fruition, Australia’s average discount variable mortgage rate would soar to 6.35 per cent by December, representing the sharpest increase in Australia’s history and the highest mortgage rate since May 2012.

In turn, average monthly mortgage repayments would soar by 39 per cent versus their level in April before the RBA commenced its rate tightening cycle.

In dollar terms, a household with a $500,000 mortgage would see their monthly repayments rise by $880, whereas a household with a $1 million mortgage would see their monthly repayments soar by $1760.

Australian house prices would crash

Australian house prices have already fallen heavily in response to the RBA’s rate hikes.

CoreLogic’s dwelling values index plunged by 1.4 per cent across five major capitals in July, which was the biggest monthly price decline in nearly 40 years.

As illustrated in the next chart, price falls have accelerated following the RBA’s initial 0.25 per cent hike in early May.

At the 5-City aggregate level, dwelling values have declined by 2.9 per cent, driven by falls of 5.4 per cent across Sydney and 3.5 per cent across Melbourne.

The RBA’s latest Financial Stability Review estimated “that a 200-basis-point increase in interest rates from current levels would lower real housing prices by around 15 per cent over a two-year period”.

Therefore, the forecast 3 per cent OCR suggests a peak-to-trough decline in real house prices of more than 20 per cent.

It is easy to see why. As shown in the tables above, the RBA’s rate hikes have already reduced borrowing capacity by 23 per cent, which will be reduced further to 39 per cent if the OCR rises to 3 per cent.

Lower borrowing capacity equals lower house prices. The equation is that simple.

Recession risks rising

It may seem strange to talk of recession when Australia’s unemployment rate is at a 48-year low of just 3.5 per cent.

However, the unemployment rate is a lagging economic indicator that will not have captured the RBA’s aggressive rate hikes over the past three months.

Never has the RBA commenced a rate tightening cycle with consumer confidence in such poor health.

Outside of the pandemic, Australian consumer confidence is tracking at its lowest level since the early 1990s recession, well below the trough experienced during the Global Financial Crisis in 200.

Household consumption is the engine room of the Australian economy, accounting for 55 per cent of growth in a typical quarter. Therefore, where household consumption goes the economy usually follows, as illustrated in the next chart.

If mortgage repayments rise as sharply as forecast, this will mean there are much less funds available for spending across the Australian economy, which will drain economic growth.

The negative drag on household consumption will be exacerbated by a sharp fall in house prices, which would make Australians feel poorer.

The RBA must, therefore, tread carefully on further rate hikes. If it tightens as aggressively as ANZ, Westpac and the financial markets are predicting, then it risks driving the Australian economy into an unnecessary recession.

Expect rate cuts in 2023

In its monetary policy statement on Tuesday, the RBA noted that “Inflation is expected to peak later this year and then decline back towards the 2–3 per cent range”.

This means that by early 2023, the RBA will likely face a situation where house prices have fallen sharply, the economy is stalling, and inflation is declining.

After going too hard on tightening, expect to see the RBA backtrack and cut rates in an attempt to stave off recession.

Read related topics:Reserve Bank

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