The Australian Economy – Cash Rates Can Go Up?
The RBA has finally relented and commenced their tightening cycle with the cash rate increasing in May ’22 for the first time since 2010 and again this month with a surprise 50bp increase. For context, 2010 was also the same year that Apple released their first iPad. Many readers will be familiar with rate cycles that move up or down and have experienced this throughout their investing journey, but there are many homebuyers, particularly recent first home buyers, that have never seen a mortgage rate increase.
Unfortunately, we have not seen the war in Ukraine come to an end, with the trauma and devastation continuing. Australia has also seen a Federal election deliver a new government with Anthony Albanese becoming the 31st Prime Minister of Australia and the Labor Party taking a decisive victory over the LNP. Finally, we have seen supply chain issues continue to dominate headlines with lockdowns in China, particularly in Shanghai causing the back up of one in five ships globally, which in turn places further pressure on cost of goods and inflation.
So, what does a rate rise, change in government, supply chain issues and ongoing overseas war mean for homeowners and the wider property market?
What Have We Seen?
Unemployment
The labour market has once again tightened in the latest print from the Australian Bureau of Statistics (April 2022), with unemployment reducing to 3.9%. This lowering in the unemployment rate has delivered the lowest unemployment rate we have seen in 50 years. Whilst the CBD office workers are slowly returning across the country, State governments have largely scrapped all restrictions and employers are now grappling with the right balance of days in the office vs working from home.
The ultra-tight jobs market has meant the power is with the employees and workplaces are increasingly needing to offer jobs on the terms of the employee to attract and retain top talent. What we haven’t yet seen is the low unemployment rate translate into much stronger wage growth which we hoped to see in the Q1 Wage Price Index (Released 18 May ’22). The ANZ is predicting the next print will reveal the increase we are looking for from the current read of 2.4% to a forecast 4-4.5%.
Economic Growth
The great post COVID-19 growth phenomime is playing out across most OECD countries, most of whom have deployed large amounts of government stimulus during the last two years and are now facing the consequences of consumer led GDP bounces. Australia’s GDP surge is largely expected to continue to be driven from pent up consumer demand driving spending.
A factor that may become a danger to this is a sustained fall in consumer confidence, which we have seen recently, with the latest print (29 May ’22 – ANZ Roy Morgan Consumer Confidence Index) showing a modest fall of 0.1% however, this follows a falling trend seen since the 2021 budget was delivered. With the election decided and the impact of the conflict in Europe having a modest impact in Australia, we expect that consumer confidence will rebound and spending will continue to drive a strong GDP print.
Where Are We Now?
Cash Rate
The RBA has officially started to tighten their policy stance and in turn the official cash rate has increased from the low of 0.10% to 0.35% after the May ’22 increase and again in June ’22 by 50bp. The RBA has switched rhetoric from normalising the cash rate in an orderly fashion to front loading rate hikes to try and get in front of key indicators; consumer spending, inflation and wage growth all showing very strong growth indicators.
We have maintained for some time that we expected the tightening cycle to begin in June ’22 and the RBA moved a month ahead of this off the back of a very strong inflation print (5.1% ABS March ’22). We reiterate that rising interest rates are not necessarily a bad thing, conversely, they can be an indication of a strong economy which we see playing out here. The key factor that will likely push the acceleration of rate rises is wage growth pushing up into the forecast 4-4.5% as this is the strongest indicator of future consumer demand.
Savings
The household saving ratio continues to sit at generational highs, currently holding at 11.4% which maintains levels not seen since 1986 in Australia. In essence, Australians have an unprecedented level of saving built up.
As interest rates increase across the household sector and home loan rates start to move, focus is moving to the potential for mortgage stress to be felt and forced property sales. Thankfully we do not foresee that there will be mass mortgage stress across the Australian residential market.
The CBA (April ’22) outlined that a rise of 1.25% in the cash rate to 1.35% total would take the average mortgage repayment to 15.5% of disposable income which is the average level of income to repayment in Australia over the last 20 years. In essence, we have a further two rate increases before we reach the long-term average for home loan repayments as a percentage of disposable income.
The RBA (May ’22) has also noted that 40% of borrowers would not require higher repayments on their home loan until rates rise 2% (total 2.1%) due to increased buffers built up over the Pandemic. If we see the expected wage growth, it may help to absorb some further pressure that rising rate would bring to households.
In addition to borrower’s ability to service their debt, the RBA’s Financial Stability Review (April ’22) suggests that 95% of borrowers would need more than a 25% drop in home prices to put them into negative equity, a huge improvement on the loan to value ratios seen in 2020 where only a little over 75% of borrowers could survive such a drop (RBA ’22).
Based on the red-hot inflation data and positive forward looking wage growth we expect to see the RBA move on rates at two to three times this year with an expected cash rate of 1.5% at the end of 2022 before pausing to monitor the effectiveness and longer-term outcome of the rate increases.
What Do We See?
Property Prices
According to CoreLogic (March ’22) for the first time since the start of the Pandemic, we have seen a fall in house prices after an unprecedented run. Melbourne (-0.1%) and Sydney (-0.5%) have led the falls with expectations that we will see the rest of the country follow.
The big four banks have all made predictions on what they expect to see in the next 12 months, with the consensus delivering an expected 10-15% price fall across all major markets.
Of course, house prices do not fall equally, and we expect to see varied results across each state market with quality projects and areas holding value and less desirable areas returning to more realistic prices.
The big four banks have all stated that whilst they expect to see a fall in house prices, their home loan books are looking healthy with arrears rates across all the major banks being at decade lows and many of their mortgage holders making extra repayments through the pandemic.
This, coupled with the additional prudent home lending guidelines APRA imposed on the banks, should see these arrears rates hold through this initial rate tightening cycle
Looking at the Melbourne market, we are starting to see rental yields across both units and houses increase for the first time since the start of the pandemic. This is playing out across most metro markets and should once again start to entice investors back into the residential markets.
We believe this will help to cushion some of the fall from first home buyers and owner occupiers slowing down.
Inflation
The 12 months to March ’22 quarter CPI figure at 5.1% delivered a big enough sign that the RBA was forced to move on rates before the wage growth they had earlier flagged they were looking for as a final signal. This strong figure is well outside of the RBA target band of 2-3% but is expected to moderate circa 4-4.5% over 2022 as we navigate some of the short term pressures such as energy costs due to war, grocery costs due to flood and supply chain drag.
One of the key contributors to the CPI print is the increase in building costs which the ABS (March ’22) has noted as rising 10.1% in the past 12 months which is the largest annual increase since the ABS started recording the data. The rapid change in building costs has been most felt by builders offering fixed price contracts which we are seeing now in the form of builders becoming insolvent or needing bailouts.
As we look forward, there is an expectation that supply chain issues, much of which currently revolves around lockdowns in China due to COVID-19, will resolve in the back end of the year and the velocity of price rises will slow.
Craig Schloeffel | Head of Investment | craig.schloeffel@payton.com.au
Disclaimer: The information contained in this document is of a general nature and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. The views expressed in this document are solely those of the author and are subject to change without notice.
Any financial projection and other statements of anticipated future performance that are included in this document are for illustrative purposes only and are based on assumptions that are subject to risks and uncertainties and may prove to be incomplete or inaccurate. Actual results achieved may vary from the projections and the variations may be material. Before deciding to make an investment with Payton, you should carefully read all of the information in the relevant Fund Information Memorandum, and consult with your business adviser, financial planner, accountant or tax adviser.
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