How high interest rates could go as the RBA kicks off a series of hikes
- Posted By Biljana Trifunoska
How high interest rates could go as the RBA kicks off a series of hikes
Megan Neil, Senior Journalist
4 May 2022, 2:41pm
Reserve Bank of Australia governor Philip Lowe has warned official interest rates could surge considerably higher, although just how high and fast remains to be seen.
Mortgage holders face potentially hundreds of dollars more in monthly repayments as the RBA embarks on a series of rate hikes to curb surging inflation, starting with Tuesday's pre-election increase.
After lifting the record-low cash rate by 25 basis points to 0.35%, Mr Lowe was clear further hikes would follow the first rise in official interest rates in more than 11 years.
"It is time to normalise rates. We don't need these emergency settings any more," Mr Lowe said.
"And it's good news. I know many people don't like rising interest rates but it's a reflection of the underlying strength of the economy that we can move off these emergency settings."
RBA governor Philip Lowe said there will be further interest rate increases, after announcing the first hike since November 2010. Picture: Getty
Given that until late last year the RBA was saying rates were unlikely to rise until 2024, Mr Lowe acknowledged the increases came earlier than under the bank's guidance "during the dark days of the pandemic".
"I know it's coming as a shock to many people but it's a testimony to the resilience of the economy and the fact that more Australians have jobs today than ever before," he said.
While admitting it was embarrassing that the RBA's forecasts turned out to be wrong, Mr Lowe said Australians knew rates would go up at some point.
Households had saved an extra $240 billion over the past two years and the average owner occupier was now more than two years ahead on their mortgage repayments, he added.
"People have understood that interest rates would go up. It's happening earlier than I expected. I'm sure it's happening earlier than many borrowers expected," Mr Lowe said.
"But we all knew that interest rates couldn't stay at this current level forever and many people have saved in advance of that day and I think that's very sensible behaviour."
The RBA has started a series of interest rate hikes, after a surge in inflation. Picture: Getty
Mr Lowe said further rate increases will be required given the outlook for the economy and inflation, but the board has not made a decision about the timing and extent of future rate increases.
Mr Lowe said the cash rate could rise to 2.5%, which would be a more normal level of interest rates.
"Over time it's not unreasonable to expect that interest rates would get back to 2.5%. How quickly we get there and indeed if we get there will be determined by how events unfold."
With inflation rising more quickly and to a higher level than expected plus evidence that wages growth is picking up, Mr Lowe said the RBA board decided now was the right time to start the process of normalising interest rates.
"The resilience of the economy means that the record low interest rates are no longer required."
Several rate hikes on the way
How quickly the RBA moves and how high rates ultimately rise depends on how "considerable uncertainties" play out over coming months.
Those uncertainties included global supply-side problems caused by the pandemic, the war in Ukraine, how household spending responds to the decline in real wages and how Australian labour costs and prices behave when the unemployment rate falls below 4%.
"It is also relevant that households have much more debt than previously, and many households have never experienced rising interest rates. So that is another aspect that we will be watching carefully," Mr Lowe said.
More than a million home borrowers have not experienced an increase in mortgage rates until now, with several hikes still to come. Picture: Getty
More than one million home borrowers have never experienced an increase in mortgage rates, with Tuesday's move marking the first rise in official interest rates since November 2010.
PropTrack economist Paul Ryan said while the initial increase in rates was small, it signalled the start of a series of interest rate rises before the end of 2022.
"Inflation has been stronger, and broader, than expected and the RBA is likely to increase interest rates several times over the rest of the year to rein in inflation," he said.
Mr Ryan noted the RBA's comments that it was not unreasonable to expect the cash rate to get back to 2.5% as it normalises rates.
"If the economy recovers as expected, the cash rate will get back to at least 2.5% over the next few years," Mr Ryan said.
AMP chief economist Shane Oliver, who expects the cash rate to rise to 1.5% by year-end and to 2% by mid-2023, said after a few initial hikes the RBA will likely pause to see what happens before doing more.
"But rates will not rise to nosebleed levels," Dr Oliver said.
"The RBA will only raise rates as far as necessary to cool inflation. It knows that high household debt levels compared to the past means households are more sensitive to higher rates and therefore it won't need to raise rates as much as in the past to cool inflation."
There will be a series of increases in official interest rates, although economists differ on how many hikes are on the horizon. Picture: Getty
National Australia Bank economists now expect the cash rate will rise to 1.35% by the end of 2022 and hit 2.6% in 2024.
"We continue to expect the RBA to move gradually from here as it assesses the impact of higher rates on households and businesses, as well as progress on wage growth and easing in supply-side pressures," the NAB economists said.
"We see three further increases in 2023 and two further increases in 2024, bringing the target cash rate to 2.6% - in line with comments made by Governor Lowe that 2.5% is seen as 'normal policy'."
ANZ economists noted the reference to a normalised rate setting of around 2.5% is broadly consistent with where they think the cash rate will get to by mid-2023.
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"We still think the cash rate will eventually need to lift to 3-point-something, albeit not for some time," ANZ's head of Australian economics David Plank said.
CBA economists forecast a 1.35% cash rate at the end of 2022 and 1.6% in February, before the key policy rate remains on hold over 2023.
Westpac economists now predict the cash rate will hit 1.75% at the end of this year and peak at 2.25% late in the first half of 2023.
Mortgage repayments rise after lenders pass on hike
All four major banks are passing on the 25 basis point increase in full on their variable mortgage rates.
The banks noted their customers have built up savings during the pandemic and many are ahead on their repayments, although some will find it difficult to manage higher rates and the rising cost of living.
"Home loan customers are generally well placed to manage rising rates with around 70% of accounts ahead on repayments - many of them by two years or more," said Maile Carnegie, group executive of ANZ's Australian retail business.
"However, we know some people are doing it tough."
RateCity analysis shows the 25 basis point increase will lift monthly repayments by $65 for someone with a $500,000 loan, $98 for a $750,000 loan and by $130 on a $1 million loan.
Should the cash rate increase to 2.6% in 2024 as NAB predicts, someone with a $500,000 mortgage could see their monthly repayments rise by $675 compared to what they are currently paying. Monthly repayments on a $750,000 loan would increase by a total of $1013 and by $1350 for a $1 million loan.
Mortgage repayments could end up rising by hundreds of dollars a month. Picture: Getty
RateCity.com.au research director Sally Tindall said the 0.35% cash rate is still incredibly low historically, but there are more hikes coming.
“Australians with a home loan should now brace for more pain, as this is only the beginning of a series of hikes ahead," Ms Tindall said.
Mr Ryan said pricing in financial markets implied the cash rate will be above 2.5% at the end of 2022, which would mean it rises by more than 2.2 percentage points.
"If mortgage rates increase by the same amount - and it is entirely possible they increase by more than that as lenders look to repair their net interest margins - that would double the average rate on new loans from the current 2.5% to 5%," Mr Ryan said.
"This is a very steep increase. It would quickly take mortgage rates back to levels not seen in almost a decade, in 2013."