Is Australia heading for an interest rate shock in 2022?
The year has been uncertain for Australian homeowners and there is a worrying sign that this pain could continue until 2022.
Is an Interest Rate Shock Happening in Australia? This is an interesting question for 2022 because an interest rate shock is already here.
Over the past month, the big banks have increased fixed rate mortgages by about 1%. If this happened at variable rates there would be a revolution!
Fixed-rate mortgages surged because panicked global markets broke the Reserve Bank of Australia’s promise to keep government bond rates at the bottom until 2024. Faced with the sell-off of bonds, the RBA has folded like a house of cards.
In doing so, the markets forced the financing costs of banks to value fixed mortgage rates, so they also rose.
Will the same pressures then arise on variable mortgages? They could. If global markets continue to panic about inflation, selling bonds and raising interest rates, it will eventually force Australian banks to take out floating rate loans, regardless of what the RBA does.
And the RBA has just illustrated that it will do what the market tells it without fighting too much.
There are several reasons to doubt this result for 2022.
The first is that the fixed rate mortgage rate hikes we’ve already seen are much larger in this cycle than in any other cycle and will trigger a significant slowdown in house prices.
The vast majority of new mortgages issued over the past two years were very cheap fixed rate mortgages which are now gone. So, as everyone is suddenly forced to switch from 1% mortgages to 2% mortgages, the housing market has been shocked by the decrease in available credit.
There is much more of this to come. All two- and three-year fixed rate mortgages issued since 2019 will continue to reset to much higher variable interest rates from 2022 and over three years.
Thus, consumer confidence should ease next year, with house price increases returning to modest or even partial declines. This will weigh on inflation.
The second reason to be confident that neither the RBA nor the banks will raise variable mortgage rates next year can be found in the same bond markets that shocked fixed rate mortgages. Although they forced short-term interest rates up for a few years, the markets also lowered longer-term yields. This is called a flattening of the yield curve:
Yield curves flatten when markets send a signal that today’s interest rate hikes will hurt growth and inflation in the future. A flattening yield curve describes either the belief that inflation will go down, or that policymakers are making a mistake, or both.
It’s important to note that this signal is global, so the markets are very clear that the breakout in inflation in 2021 – in the United States in particular – is temporary.
There is also reason to believe that Australian inflation will be lower than the receding global inflation.
China and global inflation
China is playing a key role in creating global inflation via its Covid stimulus, but its real estate crisis is increasingly playing a role in its deflation, with much more of that to come in 2022.
The Evergrande panic is over, but the hard work of consolidating $ 10,000 billion in toxic developer debt is not. This will weigh on Australia’s key commodity prices all year round and rob the economy of a lot of income, weighing on inflation as well.
Then there is the resumption of mass immigration and the very powerful role it plays in suppressing local wage growth. Australian wages are currently increasing at half the rate of American wages and this gap is likely to increase with the resumption of immigration.
As the RBA painfully clarified, there will be no increase in cash rates until wage growth is well above 3 percent and stays there. Immigration will kill this before it even starts.
Australians are unlikely to face any rate hikes in the coming year, but they might wonder if they would be better off if they did.
David Llewellyn-Smith is Chief Strategist at MB Fund and MB Super. David is the founding editor and editor-in-chief of MacroBusiness and was the founding editor and editor-in-chief of the global economy of The Diplomat, Asia-Pacific’s premier geopolitical and economic portal. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was editor-in-chief of the second Garnaut Climate Change Review.