The Reserve Bank has warned mortgage holders to brace themselves for at least a 15 per cent fall in home prices as interest rates are set to rise much steeply and rapidly.
Although financial markets expect sharp rise of the cash rate above 3%, the RBA’s outlook appears to be a bit more modest aimed at rapid hike to 2% and then wait and see.
Current market expectation is the first hike will come in June, followed up by two more moves in September and November likely to 0.25%, 0.50% and 0.75% respectively. February 2023 would likely see the cash rate at 1%.
In its Financial Stability Review (FSR), the RBA said the surge in property prices over the past two years will mostly be unwound as interest rates rise.
“Higher interest rates will increase borrowers’ debt payments. Higher inflation will reduce the funds households and businesses have to make those payments, particularly if incomes do not increase alongside higher interest rates. Loan performance could then deteriorate significantly”.
A 1% rise in home loan rates would add $500 to the monthly repayments on a $600 000 loan. Obviously, a 2% rise would push up repayments by $1 000 a month or $12 000 per year, making currently average home loans unaffordable for most borrowers. As higher inflation raises other costs, homebuyers would see their borrowing capacity drop substantially.
“If rising inflation was to erode real household incomes, some borrowers may have to draw down their accumulated excess payment buffers much more quickly and/or cut back on other spending,” it noted.
This would see home prices to drop in parallel to catch up with the purchasing power of the buyers.
The RBA sees recent home buyers most at risk from rising rates, compared to those who bought before 2021.
Cash rate hitting above 2.5% would reverse the surge of the past 18 months to the level seen in 2017-2019.
Highlights from the Report
“Financial markets expect interest rates to increase further – but rates may need to increase by more than currently expected by financial markets to contain inflationary pressures in some countries. Disruptions to supply chains due to the pandemic and the war in Ukraine, as well as sharp increases in energy and other commodity prices, will add to already high inflation. Together, these factors could depress economic growth.”
“Debt is high relative to income for many households and businesses. Some borrowers will find it harder to meet debt payments due to rising inflation and the expected increases in interest rates. Higher interest rates will increase borrowers’ debt payments. Higher inflation will reduce the funds households and businesses have to make those payments, particularly if incomes do not increase alongside higher interest rates. Loan performance could then deteriorate significantly. The current stress among highly indebted property developers in China highlights these risks.”
“Falls in financial asset and property prices could be triggered by larger-than-expected increases in interest rates, rising risk aversion, dislocation in financial markets and/or weak income growth.
Many financial asset prices remain at high levels, notwithstanding some recent declines. The prices of most types of commercial and residential property are also elevated.
Interest rates are used to value all assets and so a large increase could cause the prices of many different types of assets to fall. Rising risk aversion – possibly triggered by an escalation of the conflict in Ukraine – could lead to declines in asset prices, as could weak growth (or falls) in real income resulting from high inflation and increasing interest rates.”
“While banks have generally maintained strong lending standards, the recent increase in new high debt-to-income loans points to some risk – such borrowers are more likely than others to report repayment difficulties, but only if they have low liquidity buffers or low incomes.”
You can read the Financial Stability Review (FSR) in full here.