Rates tipped to be 3pc by early 2023

THE Reserve Bank has defied market expectations again, raising interest rates by 50 basis points to 0.85%, prompting economists to bring forward their outlook that rates will reach 3% by early 2023.

For the second month in a row, the RBA went against market expectations, this time with a 50bp increase, which was anticipated by just a handful of analysts with some forecasting 40bp but the majority expected a smaller 25bp hike.

This comes after it raised rates for the first time in almost 12 years last month by 25bp, which was above the consensus of 15bp. The official cash rate is now at its highest level since September 2019 when it was 1% before the RBA cut rates the following month to 0.75%.

Capital Economics senior economist Marcel Thieliant said the 50bp hike is consistent with its view that interest rates will peak at higher levels than most anticipate.

RBA Governor Philip Lowe said inflation in Australia has increased significantly and is expected to increase further.

“Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago. As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today’s increase in interest rates will assist with the return of inflation to target over time.

“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead.” Lowe said.

Thieliant is expecting additional 50bp hikes in July and August.

“The Bank noted that the recent decline in house prices and the pressure from soaring living costs on household finances are downside risks. However, the Bank took an optimistic view by noting that house prices were still far above pre-virus levels, “supporting household wealth and spending”. And it noted that households have built up large financial buffers and the household savings rate remains higher than before the virus struck.

“We are comfortable with our forecast that rates will peak at 3% by early-2023. That would be lower than the peak of 3.5% priced in by financial markets but well above the analyst consensus, which foresees rates peaking at just over 2%.” Thieliant said.

AMP Capital chief economist Shane Oliver’s outlook is not as hawkish, forecasting rates to rise to 1.5-2% by year-end and to peak at 2-2.5% by mid next year.

“A build up in excess household saving of around $250bn through the pandemic – which is evident in a 25% rise in bank deposits since late 2019 and many households being well ahead on their mortgage payments – imparts a degree of resilience for households which some have argued means that the RBA may have to be a lot more aggressive taking the cash rate to 3.5% or more.

“This along with the hawkish nature of the RBA’s post meeting statement this month appears to underpin futures market expectations for the cash rate to rise above 3% by year end and then 4.5% by mid next year and to then stay above 4% for the subsequent two years. However, its likely that the cash rate won’t have to go that high before the RBA achieves its aim of cooling demand enough to take pressure off inflation and keep inflation expectations down.

“While the RBA does not target house prices, falling home prices (where we expect a 10 to 15% top to bottom fall) will weigh on consumer spending (via negative wealth effects as we saw in 2017-18). All of which will start to take pressure off inflation and limit the amount by which the RBA ultimately will need to raise the cash rate by. So we expect that while the RBA will raise the cash rate to 1.5% to 2% by year end, the peak in the cash rate will come at around 2% to 2.5% by mid next year. This is well below money market expectations for a rise above 4%.” Oliver said.

Australia’s Big Four

Economists at the National Australia Bank and ANZ are forecasting a double hike in July and August. NAB believes rates will be between 1.60% and 1.85% by August and 2% by year end, and ANZ predicts a smaller 0.25% rise in July and larger 0.50% in August to 1.60%, with more upward moves likely in 2022.

The Commonwealth Bank forecasts a larger 0.50% increase in July and believe rates will reach 2.10% by November this year. Westpac also pencilled in a 0.50% hike in July and expects rates will be 2.10% by year end and 2.35% by February 2023.

Meanwhile assuming the banks pass the latest 0.50% increase in full, a borrower with a 30 year $500,000 mortgage would see their monthly repayments rise by $140 to $2,316, while a borrower with a $1 million loan would see this rise by $279 to $4,631, according to Canstar.

The May and June cash rate increases combined would see a total of $208 added to monthly repayments for a borrower with a $500,000 loan over 30 years, or a total of $415 for a borrower with a $1 million loan over the same time period.