On Tuesday, when the board of the Reserve Bank kept the cash rate at 0.1%, it marked the 137th month without a rate rise.
And yet the markets still anticipate a rise in the coming months, but soaring house prices mean it is very unlikely that rates will rise as high as the market currently expects.
November 2010 is starting to get to that point where you realise it is actually a long time ago. It was so long ago that Ash Barty had just turned professional at the age of 14 but was still a year away from playing in her first grand slam tournament.
It was also the last time the Reserve Bank raised the cash rate – from 4.50% to 4.75%. Since then, it has all been down.
Thus in the time Barty began to play tennis professionally, retire, come back, win three grand slam tournaments, become No 1 and then retire again, the Reserve Bank has not once raised interest rates.
If the graph does not display please click here
In that time a total of 1,159,402 first-home buyer owner-occupier loans have been taken out.
They should all get ready to experience something new.
Because inflation is rising faster than expected, and because the worst of the pandemic lockdowns and restrictions are behind, and because a 0.1% cash rate is not normal, the market expects rates to rise.
Tuesday’s announcement not to increase the rate ironically increased this expectation, mostly because the RBA governor’s statement left out one word – “patient”.
The governor’s statement usually ends with a line saying (as it did last month): “The Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.”
This month, however the statement ended with “The Board will assess this and other incoming information as its sets policy to support full employment in Australia and inflation outcomes consistent with the target.”
If you are reading those two sentences and don’t see the big deal, worry not – just thank yourself you don’t work in a job that has to pretend such things actually do matter.
Currency traders go through the governor’s statement looking for any changes that might – like this one does – have them thinking a rate rise is coming sooner than later.
But wow, have they got excited about rate rises.
At the start of this year the market anticipated by the middle of next year the cash rate would be up to 1.25%; now it expects it to hit that by October and by August next year it will be all the way up to 3.25% – a level it has not been since 2012.
If the graph does not display please click here
To me, that seems very exuberant.
It would be a rise of 325 basis points in little over a year.
If that were to happen, either we have just experienced the greatest economic boom since federation and wages are growing by well over 4%, or we are now in a massive recession caused by the Reserve Bank doing what the market expected despite an economy just bumping along.
To give you some context, during the mining boom it took 71 months for the RBA to raise the cash rate 300 basis points from 4.25% in April 2002 to 7.25% in March 2008.
The market’s current expectation of rate rises compared to that is a trifle absurd:
If the graph does not display please click here
Not only is the pace absurd, but so too is the level.
A 3.25% cash rate would effectively see the current average discount mortgage rate go from 3.45% to around 6.6%.
But such a rate would be rather more detrimental than in 2012 when the rate was last that high. It would actually be the most crushing rate we’ve experienced since 1990s’ 17% rates.
The reason is that house prices and mortgages have grown massively but household incomes have not.
In January 2012, when the average mortgage rate was 6.69%, the average new mortgage in NSW was $399,270 and monthly repayments for a 30-year loan of $2,462, compared with an average loan now of $754,800 and repayments of $3,369.
So mortgage size has increased 89% but, because of lower interest rates, the loan repayments have increased only around 32%. In that time the median income of someone living in NSW (using the measure of average full-time male earnings plus 33% of average women’s earnings) has also increased 30%.
That means the share of income going towards mortgage repayment is slightly higher now, but not by much.
But should interest rates go up the share of income going to pay your mortgage skyrockets.
The cash rate of 1.5% would see monthly repayments for the current average loan go up by $615 a month – and the share of income going toward the mortgage would be equivalent to the level it was in 2008 when the RBA increased the cash rate to 7.25%:
If the graph does not display please click here
Because of soaring house prices, the Reserve Bank does not need to raise the cash rate by as much as in the past to have a similar impact.
This means a 3% cash rate, let alone one next year, would likely destroy the economy and the housing market as people would be forced to spend nearly half of their income just to pay their mortgage.
That is not something that would help the economy in any way.
Greg Jericho writes on economics for Guardian Australia
