Rates sentiment yo-yo
In February, Governor Philip Lowe convinced the market there were multiple interest rate rises ahead. The market quickly priced in an expected peak in the cash rate of 4.2% (between three and four more rate rises at the time).
That was three weeks ago, and the mood has since changed.
The cash rate rise in March was accompanied by a less firm statement of intention going forward by the RBA – a small nod to the weak economic data which had been coming through in the meantime.
Nothing grabs the attention of the finance sector like a possible run on the banks, and the collapse of Silicon Valley Bank and Signature Bank in the US late last week has catalysed interest. Australian Treasurer Jim Chalmers noted that he is monitoring the situation closely for any local implications from these collapses.
The dramatic events bring to light the risks that arise from increasing interest rates rapidly. In the US, it opens the possibility of further weakness in the banking sector. This is due to unrealised losses from holding long-term securities that have declined in price as interest rates have risen. Despite intervention at both ends of the crisis – to shore up depositor confidence and to provide liquidity to banks under pressure – the Federal Reserve will likely have to recalibrate it’s tightening of monetary policy.
In Australia too, financial markets have reacted by greatly reducing their expectation for a cash rate rise in April from close to 50% at the start of March to 0% today. (Zero chance may be overdoing it – if we were to see a strong labour market report tomorrow, the RBA would likely still be considering a rate rise).
Source: ASX
However we get there, a pause in rate rises could be a good thing for the Australian economy.
Not only have we just had 10 interest rate rises in a row and the Australian economy has already shifted to a slower growth path, but the full impact of those rate rises has not yet been felt – the so called ‘mortgage cliff’.
The share of fixed rate mortgages in Australia rose from 20% in 2019 to almost 40% in 2021 as the RBA dropped the cash rate target to just 0.1% (with many borrowers locking in the record low).
Fast forward to 2023 and almost two-thirds of fixed rate mortgages are set to expire this year and be reset to current variable rates which have increased significantly in response to a sharp rise in the cash rate. Fixed rates as low as 2% will reset to current variable rates that are above 6%.
The abrupt increase in monthly mortgage interest payments, which is likely to impact almost a million households through 2023, has come to be referred to as the ‘mortgage cliff’. The term is a bit of misnomer as the switch is likely to happen in a continuous series of steps, depending on when fixed rate contracts expire through the year, rather than in one gigantic cliff.
Deloitte Access Economics estimates that the size of the ‘mortgage cliff’ could be as large as $21 billion, equivalent to 2% of household spending. This estimate on spending is likely to be at the upper end, as many consumers may dip into savings rather than absorbing the impact by only reducing spending. Nonetheless, the lagged impact of rate rises put through to date will be more than trivial, and it will continue to play out in Australia over 2023.
This blog was co-authored by Lester Anthony Gunnion, a Manager in the Deloitte Access Economics team.
