What is it that borrowers should expect to see happen to their mortgage rates over the next few years? In particular, what does it mean now that the Reserve Bank have just lifted their pick for how high their official cash rate goes from 2.5% to just under 3.4%?
We’ve actually been there before.
Back from around the middle of 2014 to the middle of 2015 the cash rate was 3.5%. Over that time we saw floating mortgage rates at around 6.7%. They are currently about 4.8%.
Back then the one-year fixed rate almost got to 6% and currently the best rates are near 3.7%. The three year fixed rate got to 6.3% and currently it sits mainly near 4.7%.
Will mortgage rates at these levels cause problems?
For anyone who has lied on their mortgage application when borrowing over the past two years the answer may be yes. I write “lied” because all borrowers in recent years have had their lender require that they be able to service a mortgage rate not where they start, but at levels close to and above 6.5%. Those who were honest about their expenses should be okay.
For the vast majority of borrowers the peak in interest rates which looks likely to occur in the second half of 2023 will not lead to forced sale of one’s house. But it will lead to some sharp reductions in spending which is exactly what the Reserve Bank wants to see happen.
Their goal when tightening monetary policy is not to cause excess weakness in house prices or drive a lift in mortgagee sales. They want businesses to think twice before they raise their selling prices because it is those prices which go into the calculations for the inflation rate which the Reserve Bank wants safely back in a range from 1% to 3%.
How businesses will respond
Businesses will react to worries about householders not buying their products, and especially a scenario where they raise their prices but inventories of unsold goods are building up. And it is generating such worries which forms the other weapon at the Reserve Bank’s disposal beyond changes in the official cash rate – their words.
The more they can talk scarily about upside risks for interest rates and the need for restraint, the more they can encourage businesses to look to maintain profits as costs rise by seeking efficiencies rather than just adopting a cost-plus mentality and increasing their prices.
This is somewhat hard for many businesses to do considering the extra costs being imposed by government such as a new public holiday and higher minimum wages. But these changes may assist a long-overdue move by businesses towards achieving profit growth by capital expenditure aimed at boosting output per staff member rather than simply hiring more foreign labour.
The upshot is that while the Reserve Bank has pencilled in a peak for their cash rate of 3.4%, I am going to for now stick with the 3% peak I’ve been writing about since the middle of last year. This is especially so in light of the fact that we can already see house prices falling and we know that will have an impact on already quite depressed levels of people’s spending intentions.
There is also a weeding out process set to run through the hospitality sector, along with a decline in house building perhaps before the end of the year as many inexperienced, under-capitalised developers realise they cannot get staff, supplies, or even finance.
For now, a peak in floating rates comfortably below 7% looks likely, and the one-year fixed rate peak looks like coming in below 6%. But be aware that every monetary policy tightening phase is experimental, and this one perhaps more so than ever as we exit a global pandemic. Hence why I so strongly advocated fixing five years at 2.99%!
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