As reports emerge of the US Federal Reserve raising interest rates by 25 basis points, Australia appears to be left in solitude as one of the few central banks that has not hiked rates. The US Federal Reserve’s latest rate hike was accompanied by the Bank of England, which recently hiked rates in the UK to 0.75%. There is still a lot to unpack for the Australian population, as interest rate hikes would not go unnoticed.
Australia’s interest rates are currently at an all-time low of 10 basis points, prompting a massive wave of mortgage lending across the country. Australia stands in stark contrast to the rest of the world, where economies have taken a decidedly tighter approach to lending in response to rising inflation.
The Reserve Bank of Australia (RBA) appears to have taken an unfamiliar approach, allowing underlying inflation to continue rising before raising interest rates. Consumer prices in Australia are approaching alarming levels amid global challenges. In fact, headline inflation has already breached the RBA’s 2-3% target range, fueling great anticipation of a rate hike.
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What happens if interest rates rise?
It is no surprise that announcing a rate hike would not be good news for consumers and businesses. Mortgage loans could become more expensive after a rate hike, which would adversely affect the past and future flow of borrowers. Those with a variable mortgage rate may not see an immediate impact, as the magnitude of the impact can vary for different types of borrowers.
With Australia taking on a critically high level of mortgage debt, the economy appears vulnerable to changes in interest rates. Even a single percentage point change can cost borrowers dearly and stretch their monthly interest payments well over budget.
At a time when multiple tight interest rates are expected from the RBA, Australians’ debt could be piling up faster than one can imagine. Small monthly increases in the cash interest rate could result in a gradual increase in rent payments over the long term.
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Australia interest rate forecast
The RBA has continued its longstanding streak of maintaining ambiguity over a rate hike. The central bank has not provided any clear guidance other than hinting at a rate hike earlier than previously announced.
At the same time, a different scenario is emerging in bond and interest rate futures markets, with participants confident that a rate hike could be implemented by mid-2022. However, many commercial banks have already started raising interest rates on their fixed-rate mortgages.
In particular, the three-year mortgage rates offered by the Big Four banks have seen a sharp rise in the recent past. The Commonwealth Bank of Australia (ASX:CBA), one of the Big Four banks, recently said that mortgage rates may need to rise faster than the benchmark cash rate given rising bank funding costs. The bank expects interest rates to rise to 1.25% next year.
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The RBA governor has provided some much-needed relief, noting that the average Australian borrower is two years ahead on mortgage payments. Despite the demand, a sizeable chunk of the borrower population could be affected by rising interest rates, with the worst-case scenario being an increase in bad assets for banks.
There are concerns that commercial banks may be juggling between providing reasonable interest rates and maintaining balance sheets. With mortgage lenders sitting comfortably in the lap of a low interest rate environment, a rate hike could bring about huge changes. A likely outcome of these developments could be Aussies turning to saving to fund discretionary consumption spending.
bottom line
The biggest threat in the current economic environment appears to be a potential rate hike. Even as lending slows due to tighter credit restrictions, a sizeable population could be affected by higher interest rates. Some experts assume that the economy could even slip into recession if interest rates were to rise sharply. Thus, the responsibility now rests with the RBA to cautiously raise interest rates without harming the country’s financial stability.
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