Australia is more vulnerable to higher interest rates - here’s why

AMP senior economist Diana Mousina said there are three key reasons why Australian consumers are impacted greater by rate hikes than other countries.

High levels of household debt

While household debt has been decreasing since 2007 in most countries, this isn’t the case for Australian households.

“In Australia, the average household debt is at 187% of their income, a record high,” Ms Mousina said.

“A higher debt load [as a share of income] means that interest rate changes are felt more acutely.

“For example, a 0.25% increase in interest rates in the US is like the equivalent of a 0.45% increase in Australia for consumers with housing debt – given the relativities in household debt.”

Large share of fixed-rate home loans to expire

With many fixed interest rates expected to expire in the second half of 2023, Ms Mousina said this is another driving force for consumers’ vulnerability to rising interest rates.

“On the RBA’s own estimates, around 38% of households with a mortgage will see a lift in monthly repayments of 40% or more if interest rates rise by 300 basis points [the RBA has so far increased interest rate by 225 basis points], which is around 1.3 million households,” she said.

“This is a very large increase in housing costs for a good share of the population and is too large to be compensated by a rise in wages growth.”

For example, CommBank alone has $117 billion in fixed-rate mortgage terms expiring by the end of 2023.

Higher share of variable rate mortgages

Borrowers on variable rate mortgages are also vulnerable – a double whammy.

“Households with variable mortgages feel the impact of rate hikes as soon as their minimum repayments change,” Ms Mousina explained.

“There is a very high sensitivity of households to near-term changes to interest rates because of the faster flow-through to changes in repayments for households with debt.”

What is the effect on the economy?

Ms Mousina noted the impact of higher interest rates are both a blessing and a curse.

“In the short term, this is negative for consumer spending in Australia but in the medium term it could be positive for the economy because it should mean that the RBA does not need to raise interest rates as much to get demand and, therefore inflation to slow,” Ms Mousina said.

“While consumer spending is holding up for now, we see it slowing to under 1% per annum by the second half of 2023 – well below its more normal levels of around 3%.”

So how high will interest rate rises go?

The current RBA cash rate is sitting at 2.35% – will it go any higher? Or the more important question, how high will it go?

AMP economists say the cash rate will peak at 2.85% by year’s end – this is comprised of two more 0.25% increases.

Here are what the major banks predict.

• Westpac: Westpac chief economist Bill Evans revised his forecast from 3.35% last month, to 3.6%. This implies a further 50 basis point increase in October.
• ANZ: ANZ economists predict the cash rate to reach 3.35% by year’s end. This implies a 50 basis point increase in October, followed by two 25 basis point hikes in November and December.
• NAB: NAB economists predict 25 basis point hikes at both the October and November meetings, taking the final cash rate to 2.85% by year’s end.
• CommBank: CBA head of Australian economics Gareth Aird predicts the final cash rate to sit at 2.60%.

Originally published by Savings.com.au