The Reserve Bank of Australia’s recent call that neutral interest rates could be about two percentage points above current record lows, marks a line in the sand that borrowers should prepare for, according to discussions at a recent AMP Capital Insights forum.
“I think it's just sort of a line in the sand – they're saying ‘we think neutral is around about here in a long-term context and eventually we might get there’ but more importantly, if that's neutral then currently policy is very easy,” AMP Capital’s Head of Investment Strategy and Chief Economist, Shane Oliver said.
The neutral real interest rate – where economic growth reaches its potential but inflation is stable – has been declining over the last decade as the impact of the global financial crisis has dragged down global growth and inflation.
The US Federal Reserve has regularly stated that its neutral rate is about 3 per cent but more recently, Chair Janet Yellen said that rates may already be close to neutral at 1 to 1.25 per cent.
While the US has already raised interest rates twice this year, there is no imminent expectation that the RBA will aggressively begin hiking rates, although borrowers should be prepared for increases to occur in the next year or two.
“There is a danger that if the RBA is serious and pushes rates up to 3.5 per cent, you could see quite a sharp cutback in consumer spending and it would be a bit of a drag on the Aussie economy, which all suggests they probably won't do that,” Oliver said.
Oliver added the average Australian household currently uses approximately 8.6 per cent of their disposable income to pay interest on their debt (although that figure is an average and includes the near one-third of people who own their home outright and those who rent – so it’s much higher for those with a mortgage).
If rates rose by 200 basis points on top of recent bank rate hikes, that ratio would soar to approximately 12 per cent.
“It's quite a sharp hike – in other words you'd have 3.5 per cent less of disposable income to go and spend which would be quite a drag on the economy.”
When the ratio reached 11.5 per cent in 2011, a sharp slowdown in retail sales and consumer spending followed and those measures remain soft today.
The Westpac Melbourne Institute Index of Consumer Sentiment has been in negative territory for eight consecutive months, suggesting an already weak outlook for consumer spending. In contrast, the recent NAB business survey showed conditions and confidence are now around the pre-financial crisis highs.
The ratio of disposable income to mortgage interest reached a peak just prior to the global financial crisis, but Oliver noted that people were much more positive at that time and had the capacity to dip into their home equity.
The prudential regulator has recently implemented several policies aimed at cooling the east coast residential property market as well as higher regulatory capital requirements for the country’s five largest banks.
While housing lending rose for owner-occupiers in May, it fell for investors as the impact of recent investor loan interest rates had some effect.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.
This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.