• Thu. May 23rd, 2024

Why Reserve Bank of Australia interest rate rises could cause a recession

Bynewsmagzines

Feb 10, 2023
The Reserve Bank

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Experts fear the Reserve Bank’s severe interest rate rises could cause a recession, with Governor Philip Lowe now accused of underestimating the danger of higher unemployment.

Interest rates have this week gone up for a ninth straight month to a new 10-year high of 3.35 per cent.

The Reserve Bank released new forecasts on Friday, three days after Dr Lowe signalled rates would keep increasing in 2023 to tackle the worst inflation in 32 years.

The Reserve Bank’s 3.25 percentage points of rate rises since May, 2022 have marked the most severe pace of monetary policy tightening since the Reserve Bank first published a target cash rate in January, 1990.

AMP Capital chief economist Shane Oliver said draconian rate rises risked causing a recession.

The Reserve Bank's severe interest rate rises could cause a recession with Governor Philip Lowe now accused of underestimating the danger of higher unemployment

The Reserve Bank's severe interest rate rises could cause a recession with Governor Philip Lowe now accused of underestimating the danger of higher unemployment

The Reserve Bank’s severe interest rate rises could cause a recession with Governor Philip Lowe now accused of underestimating the danger of higher unemployment

‘We are getting more concerned though that the RBA is raising rates too far in response to inflation which is a lagging indicator and is not paying enough attention to the lagged flow-through of rate hikes to the economy,’ he said.

‘This is increasing the risk of a recession that we don’t have to have and with that, a bigger rise in unemployment and a bigger fall in home prices.’

Dr Oliver said variable mortgage rates of 6 per cent in 2023 would be just as economically damaging as the 17.5 per cent RBA interest rates of 1990 that led to a recession in 1991 when Paul Keating was Labor treasurer.

‘Given the three-fold increase in household debt to income ratios over the last 30 years, mortgage rates around 6 per cent now are already pushing above the equivalent of the 17 per cent level that helped tip the economy into the early 1990s recession and risking a sharper rise in mortgage stress than we have been allowing for,’ he said.

AMP Capital chief economist Shane Oliver said draconian rate rises risked causing a recession, especially if they rose to 4.1 per cent as the futures market (Australian Securities Exchange graph, pictured) is predicting

AMP Capital chief economist Shane Oliver said draconian rate rises risked causing a recession, especially if they rose to 4.1 per cent as the futures market (Australian Securities Exchange graph, pictured) is predicting

AMP Capital chief economist Shane Oliver said draconian rate rises risked causing a recession, especially if they rose to 4.1 per cent as the futures market (Australian Securities Exchange graph, pictured) is predicting

Dr Oliver said a recession would be almost certain if RBA rates rose three more times to 4.1 per cent, which the futures market is now predicting. 

A recession in 2023 or 2024 would mark the first interest rate-induced economic contraction in 32 years. 

The RBA’s new statement on monetary policy predicted inflation would remain above its 2 to 3 per cent target until June, 2025, after last year hitting 7.8 per cent for the first time since 1990.

While the RBA believes inflation peaked in late 2022, it revised its forecasts to have the consumer price index falling to 6.75 per cent by June, 2023, up from a previous prediction of 6.25 per cent.

The Commonwealth Bank’s head of Australian economics Gareth Aird said the Reserve Bank was too pessimistic about inflation, as global supply constraints were resolved.

‘We think the speed at which inflation will recede will surprise the RBA,’ he said.

‘Upstream inflation pressures are dissipating quickly in some key parts of the economy. 

‘And pricing power will wane for businesses as demand slows significantly. 

‘Goods inflation is likely to recede quite quickly.’

Interest rates have this week gone up for a ninth straight month to a new 10-year high of 3.35 per cent

Interest rates have this week gone up for a ninth straight month to a new 10-year high of 3.35 per cent

Interest rates have this week gone up for a ninth straight month to a new 10-year high of 3.35 per cent

Mr Aird said the RBA had also underestimated the prospect of higher unemployment as a result of its rate rises.

Fixed rate borrowers face 65 per cent surge in repayments

$500,000: $2,099 a month under a 1.92 per cent fixed rate in May 2021 becomes $3,469 a month under a ‘revert’ variable rate of 7.18 per cent

$600,000: $2,518 a month under a 1.92 per cent fixed rate in May 2021 becomes $4,163 a month under a ‘revert’ variable rate of 7.18 per cent

$700,000: $2,938 a month under a 1.92 per cent fixed rate in May 2021 becomes a $4,856 a month under a ‘revert’ variable rate of 7.18 per cent

$800,000: $3,358 a month under a 1.92 per cent fixed rate in May 2021 becomes $5,544 a month under a ‘revert’ variable rate of 7.16 per cent

$900,000: $3,778 a month under a 1.92 per cent fixed rate in May 2021 becomes $6,237 a month under a ‘revert’ variable rate of 7.16 per cent

$1,000,000: $4,197 a month under a 1.92 per cent fixed rate in May 2021 becomes $6,930 a month under a ‘revert’ variable rate of 7.16 per cent

Methodology: RateCity calculations showed that in May 2021, the Big Four banks offered average, two-year fixed rates of 1.92 per cent. The 7.18 per cent ‘revert’ rate is default variable rate based on Reserve Bank of Australia cash rate of 3.85 per cent by May 2023, as Westpac and ANZ are predicting. Relates to a 25-year loan. Loans above $750,000 would have revert rate of 7.16 per cent because NAB has a lower rate for bigger loans.

‘On balance we believe the RBA’s forecasts underestimate the impact that their policy tightening will have on the economy,’ he said.

‘The RBA’s forecasts for the unemployment rate look optimistic.’ 

Mr Aird said the Reserve Bank’s forecasts of gross domestic product slowing to just 1.5 per cent by December 2023 meant the jobless level would next year be higher than their predictions.

‘No economist has a crystal ball. But the RBA’s forecast profile for the unemployment rate looks too positive to us given their GDP forecasts,’ he said.

Unemployment in December remained at a 48-year low of 3.5 per cent but the Reserve Bank is expecting it to rise to 4.1 per cent by June 2024.

Mr Aird said the jobless rate was likely to be a bit higher, rising to 4.4 per cent by the middle of next year.

AMP is forecasting a 15 per cent to 20 per cent plunge in property prices, compared with the peaks in 2022. 

Should that materialise, Sydney’s median house would fall by $283,392 from $1,416,960 in April 2022 to $1,133,568 when the market bottomed out in 2023 or 2024. 

In the year to January, Sydney prices fell by 15 per cent to $1,205,618.

Despite that, an average, full-time borrower on $92,030 salary, with a 20 per cent deposit would have a dangerous debt-to-income ratio of 10.5. 

Variable mortgage rates have already risen by 43 per cent since May 2022, with borrowers with an average $600,000 loan now set to pay $3,303 a month with the latest rate rise, up from $2,306 nine months ago.

This has coincided with Commonwealth Bank variable rates soaring from 2.29 per cent to 5.22 per cent to reflect moves in the RBA rate.  

The Commonwealth Bank, Westpac and ANZ are forecasting a RBA 3.85 per cent cash rate by April or May with two more rate rises.

This means a borrower who took fixed their mortgage at an ultra-low 1.92 per cent in May 2021 face moving straight to a 7.18 per cent ‘revert’ variable rate.

This would equate to an abrupt 65 per cent surge in monthly repayments on a 25-year loan.

Fixed rate contracts two years ago stated borrowers would move on to a ‘revert’ rate that was 3.43 percentage points above the RBA cash rate when it was at a record-low of 0.1 per cent. 

Source: | This article originally belongs to Dailymail.co.uk

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