Why interest rate hike is a threat to Australia’s booming housing market?

Highlights

• The US Fed and the Bank of England have recently raised interest rates to fight inflation, unlike the RBA.
• Concerns loom that rising interest rates could make mortgage lending more expensive, affecting borrowers adversely.
• The Commonwealth Bank of Australia (ASX:CBA) expects the cash rate to rise to 1.25% next year.

As reports surface about the US Fed’s move to raise interest rates by 25 basis points, Australia seems to be left in solitude as one of the few central banks to have not raised interest rates. The US Fed’s latest interest rate hike has been accompanied by the Bank of England, which recently raised its interest rates to 0.75% in the UK. There is a lot left to unpack for the Australian population as interest rate rises would not come without consequences.

Currently, Australia’s interest rates are at an all-time low of 10 basis points, which has incited a wave of heavy mortgage lending across the country. Australia stands in stark contrast to the rest of the world, where economies have decidedly taken a tighter approach to lending due to rising inflation.

The Reserve Bank of Australia (RBA) seems to have taken an unfamiliar approach, allowing underlying inflation to rise further before increasing interest rates. Consumer prices in Australia are inching towards alarming levels as global challenges unfold. In fact, the headline inflation has already surpassed the RBA’s target band of 2-3%, causing much anticipation surrounding a cash rate hike.

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What will happen if interest rates rise?

It is no surprise that the announcement of an interest rate hike would not be good news for consumers and businesses. Mortgage lending could become more expensive following a rate hike, adversely affecting the past and future stream of borrowers. Those with a variable mortgage rate might not see an immediate effect as the level of impact could differ for different types of borrowers.

With a critically high value of mortgage debt being taken out in Australia, the economy seems susceptible to any changes in the interest rate. Even a single percentage point change can cost borrowers dearly, stretching their monthly interest payments significantly beyond budget.

At a time when several closely timed interest rates are expected from the RBA, the debt on Australians may pile up faster than one can imagine. Small hikes to the cash rate each month could add up to an incremental rise in rental payments over a long-term period.

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Australia’s interest rate forecast

The RBA has continued its longstanding streak of maintaining ambiguity surrounding a cash rate hike. The central bank has given no clear indication, except hinting at introducing a rate hike earlier than previously stated.

At the same time, a different scenario is panning out in the bonds and interest rate futures markets, where participants are confident that a rate hike could be implemented by mid-2022. However, many commercial banks have already begun to raise the interest rate on their fixed-rate mortgages.

Specifically, three-year mortgage rates offered by the big four banks have seen a sharp uptick in the recent past. The Commonwealth Bank of Australia (ASX:CBA), one of the big four banks, recently stated that mortgage rates might have to rise faster than the benchmark cash rate amidst an increase in bank funding costs. The bank expects the cash rate to rise to 1.25% next year.

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Providing some much-needed relief, the RBA governor has pointed out that the median Australian borrower is two years ahead in mortgage repayments. Despite the claim, a substantial chunk of the borrower population could be impacted by rising interest rates, with the worst-case scenario being a rise in non-performing assets for the banks. 

Concerns loom that the commercial banks could be left juggling between providing reasonable rates and maintaining balance sheets. As mortgage lenders sit comfortably in the lap of a low-interest-rate environment, a rate hike could bring enormous changes. A likely outcome of these developments could be Aussies turning to savings to finance discretionary consumer spending.

Bottom line

The biggest threat in the current economic environment appears a potential rise in interest rates. Even as lending numbers dwindle owing to tighter lending restrictions, a sizeable population could be affected by higher interest rates. Some experts believe that the economy could even slip into recession if a massive rate hike is implemented. Thus, the onus is now on the RBA to carefully drive up the interest rates without hampering the nation’s financial stability.

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