In this weekly, we shine the spotlight on the household sector and the trends that are beginning to emerge as households respond to higher interest rates and above-target inflation.
Analysis: The household sector is beginning to react to rising interest rates
- In this weekly, we shine the spotlight on the household sector and the trends that are beginning to emerge as households respond to higher interest rates and above-target inflation.
- It is still very early to fully assess the impact, but based on the limited data to date, the most pronounced effect has been on the housing market with house prices in Sydney down around 4% since the start of the year and prices in Melbourne down 2.6%.
- The NAB recently revised its house price forecast, recording an 18% decline over the next two years, mainly due to less borrowing capacity due to higher rates. Updating our models with NAB’s cash rate assumption results in a 22% decrease in borrowing capacity.
- RBA modeling suggests that if house prices were to fall by 20%, the share of loans in negative equity would increase by only 2.5%. A more moderate decline in house prices of 10% would only see 0.4% of loans to negative equity.
- A larger decline in theoretical borrowing capacity occurs when assuming fixed rates or market prices for the spot rate, resulting in a 32% decline in borrowing capacity. Regardless of the cash rate assumption used, house prices will likely continue to correct, but not necessarily as significantly as borrowing capacity.
- Consumer confidence was also hit hard, but details show that much of the decline was due to too high inflation. Since July, concerns about interest rates have also increased, with those polled after the RBA having confidence levels 7.4% lower than those polled before.
- Overall, consumer spending has been resilient according to retail sales data for May, although a broader measure of spending based on banking transaction data suggests that spending could start to slow with little or no no growth in April and May.
- Overall, it looks like households are resisting the combination of rising and rising inflation so far, likely supported by strong labor markets. That should keep the RBA for now in relatively aggressive riding.
- The RBA minutes just released and a speech by Deputy Governor Bullock suggest that the RBA will continue to move forward relatively aggressively:
- The RBA board had assessed the cash rate at the July meeting as being “well below the lower range of nominal neutral rate estimates”. Neutrality was maintained by the Governor at around 2.5%, while the models give a rate closer to 3%.
- Bullock revealed modeling rate hikes on individual borrowers that assumed “mortgage rates increase by about 300 basis points, which is largely informed by recent market prices.”
- Bullock stressed the importance of monitoring trends in the household sector: “The Board will be watching closely…how households react to the combination of rising interest rates and rising prices.” Bullock also noted that there is a need to bring rates to some concept of neutral, which is a bit higher than where we are.
Chart 1: The fall in real estate prices is accelerating
Chart 2: Implied borrowing capacity has declined as interest rates rise
Chart 3: Consumer confidence is at recessionary levels
Chart 4: Consumer spending indicators based on bank transaction data may slow, but data is not seasonally adjusted