Interest rates

While experts are scaring everyone about interest rates, here are five reasons why they won’t rise as high as expected

Soaring costs for everyday groceries and fresh food, exorbitant fuel prices and, to top it off, a series of punitive Reserve Bank interest rate hikes, adding hundreds of dollars per month to the cost of an average mortgage.

And to top it all off, just about every expert you listen to will tell you that the worst, much worse, is at hand when it comes to interest rates.

But there are a few basics that most have abandoned in their quest to scare everyone away. And at the very top of that list is logic.

Australia is particularly vulnerable to an economic slowdown due to interest rate hikes for a number of reasons. Unlike the United States, where many households have fixed mortgage rates for the term of their loans, our mortgages are underwritten at variable rates. Even our fixed rate loans are relatively short term.

Thus, interest rate movements have a direct impact on Australian households more than in many other countries.

Add to that our huge household debt – mostly focused on real estate – and the kind of rate hikes predicted by pundits would hit the real estate market hard and could push the economy into recession.

It would be a disaster. And that would force the RBA to cut interest rates.

A few weeks ago, money markets were tipping official rates over 4% by the middle of next year.(ABC News: Daniel Irvine)

Does RBA Really Want Everyone to Go Bankrupt?

The answer is NO – or at least we hope it is.

If you believe all the predictions, official interest rates in Australia are expected to hit 3.5% by the middle of next year.

Believe it or not, but it was actually reduced a bit. A few weeks ago, money markets were tipping official rates over 4% by the middle of next year.

If that happened, mortgages would cost more than 6%, compared to the lowest rates of less than 2% offered at the start of last year.

Imagine the impact on the approximately 165,000 first-time home buyers who purchased real estate last year. Then think of the enormous pressure it would place on millions of Australian households who have endured years of anemic pay rises.

It’s a long-established banking decree that when it comes to housing, Australians will do almost anything to ensure they keep a roof over their heads, even if it means cutting expenses. for almost all other essentials.

It’s very beautiful. But, while we all talk about the strength of our economy and our exports like energy and iron ore, it’s worth remembering that around 60% of our economic growth comes from household spending.

If spending falls off a cliff, due to a rapid rise in interest rates, we will tip into recession. And then we’ll have a much bigger problem.

Rate hikes hurt more these days

It’s not because we’re not as tough as we used to be, but we’re certainly a lot more vulnerable than we once were.

In 1994, the RBA suddenly raised its rates. Between July of that year and December, the official rate rose from 4.75% to 7.5%. It was done in just three steps, with two of those increases looking more like jumps of 1 percentage point each.

So what has changed? Have we become wimps?

No way. The big change is in the value of real estate and the size of our loans. At the time, the median price of a house in our largest city, Sydney, was $169,000. These days, the same place will set you back $1.25 million.

This huge jump in valuation has been financed by debt and, because we owe so much more than before, the effects of rising interest rates are magnified.

If you compare household debt to income, we are vying for global dominance with Switzerland, the Netherlands, Denmark and Norway.

As a result, our economy is now hypersensitive to interest rate fluctuations. This means that the RBA has less interest rate leeway than many other countries. It also means he has to be a lot more careful when it comes to pricing.

Will rate hikes solve the inflation problem?

Finally, maybe. The question is how much damage they will cause in the process.

Here’s the dilemma: prices are determined by two factors, supply and demand.

Much of the dramatic rise we have seen in the prices of food, fuel, fertilizer and manufactured goods is due to supply issues; starting with shipping delays and exacerbated by Russia’s brutal invasion of Ukraine.

And this is where things get complicated. For interest rates, the only tool available to central banks, are designed to influence demand. They will not solve supply problems.

While it is true that you can reduce demand to meet supply, this will end up inflicting much more harm on individuals and the economy in general.

It’s not like we spent like mad because we had money burning a hole in our pockets. Most are already doing it hard, struggling just to keep their heads above the tide of rapidly rising prices.

Either way, the problem of supply-driven inflation is likely to resolve itself. Think of it this way. The price of carrots may have doubled in a month due to shortages. It’s 100 percent inflation. However, if they remain at this higher price, there is no inflation.

Carrots are still expensive. But the price does not increase.

Philip Lowe looks at the camera, with a blurred podium in the background.
Dr. Philip Lowe and the RBA will be looking for what they think is the “neutral” rate; the Goldilocks level.(ABC News: John Gunn)

Danger of overtightening

There is a delayed reaction when it comes to interest rates. Economists call it “the lag”, which makes it difficult to judge how much pressure to apply to achieve the desired effect.

It’s like getting your foot stuck on the brake, having no reaction, then pushing even harder, only to find you’ve locked the wheels and are skidding off the road.

After starting late, all central banks are now in panic mode. America pumps through triple hikes. We just had two doubles. New Zealand is the same.

There is no doubt that interest rates need to rise. We’ve been through a period of essentially zero percent interest rates: free money.

In the entire history of civil society, 5,000 years of commerce, such an idea was inconceivable — until ten years ago.

This caused asset price bubbles in everything from real estate to stocks and even imaginary assets delivered via the internet.

Unraveling these distortions is extremely difficult, potentially painful, and with the very real prospect of getting the wrong foot by policy makers.

This is why the “normalization” of interest rates should take years, even decades. It needs to be done slowly, which global central banks acknowledged last year but, temporarily, seem to have given up on in their quest to stifle inflation.

No one knows what normality is anymore. Central banks, such as the RBA, are looking for what they believe to be the “neutral” rate, the Goldilocks level that keeps economic growth at the right temperature.

It could well be 3.5 or 4%. However, getting there at a breakneck pace, as we are doing now, is a dangerous course of action that has the potential to backfire in spectacular fashion.

A man wearing a face mask and a blue down jacket walks past a tall building with a Chinese flag waving on a pole.
Banks have slammed the brakes on global growth at a time when the Chinese economy is in dire straits.(Reuters: Jason Lee)

Slow hikes… or have to cut?

At the start of last year, money markets began to go haywire, aggressively pricing rate hikes as inflation began to reassert itself.

This behavior has been derided by nearly every central bank in the world, including our own, who have insisted that rates will not rise for years. Eventually, however, they had to capitulate.

However, in their mad rush to catch up with markets, they have held back global growth at a time when China’s economy is in dire straits as the short-term impact of its tough COVID-zero policies collides with longer-term ones. . demographic challenges.

China’s birth rate has halved, its population has peaked, and its rapidly aging workforce is shrinking.

The IMF, World Bank and OECD have all lowered their growth forecasts, while the outlook for recession, which seemed dim just a few months ago, has suddenly increased.

America saw an unexpected contraction in the March quarter. If, as now feared, the same outcome occurs in the just-ended June quarter, then – technically – the US could already be in a recession.

About a fortnight ago, money markets began a drastic reassessment of the future of interest rates. They started to reduce them.

Finally, the penny seems to have gone down. If we continue to drive rates up at this rate, it could have a limited impact on inflation and only serve to kill demand, creating – unnecessarily – a recession.

This wake-up call has yet to reach many economists, pundits and even global central banks, who have become obsessed with one thing: stamping out inflation.

And that leaves the RBA and its ilk with only two choices: start slowing the speed of rate hikes now or tip the economy into recession and be forced to start cutting next year.

The destination will be the same. Rates will be lower next year than many predict. How to get there is the unknown.