Savers and borrowers both have their fingers crossed

The Reserve Bank has decided to keep rates on hold for the time being, but next month's meeting could bring an interest rate hike. That would mean the headline variable mortgage rate in Australia would advance from 7.8% to 8.05%. The official “discounted” rate would also rise by 0.25 percentage points from 7.05% to 7.3%. 

This would place home loan rates at about 0.1 percentage points above their historical average since 1993, which is 7.7%. Accordingly, nobody could seriously argue that rates are unreasonably high – recall mortgage rates hit 9.6% in August 2008 – given that private wages growth is running strongly at a 4.1% per annum rate (including bonuses), disposable household incomes have risen by more than 8% over the last year, and the unemployment rate is near all-time lows at 4.9%. 

Nevertheless, higher rates would mean more repayments for the 90% or so borrowers with variable-rate loans. On the other hand, an increase in the RBA’s cash rate usually means that households who are net savers benefit from better returns on their cash investments as compensation for higher inflation. 

Banks are always looking to improve margins, and it would not surprise me to see them pass on, say, the full 0.25 percentage point RBA increase to their mortgagors (if and when rates do rise), but only give savers a slimmer increase.

In this way, the banks can widen the “spread” or “net interest margin” between the rates at which they borrow from depositors and the much higher – net 2.5 percentage points on average – rates they charge home loan and business borrowers. 

If the RBA does not hike today, savers can consider themselves hard done by, while borrowers will have received a puzzling reprieve. One would be left concluding that Australia’s central bank has developed an unusual tolerance for high core inflation, which is running about 40% above the RBA’s official 2.5% per annum target.

The “consensus” view is, in fact, that the RBA will not touch rates today. In a survey of 25 economists by Bloomberg, 21 projected that rates would remain on hold. As another guide, the financial markets are only pricing in a circa 15% probability of a hike. So, all things being equal, one would have reasonable grounds for thinking that the RBA will not step up to the plate, as it has threatened to do so many times this year. If they once again defer the decision to deal with inflation this month, most economists think we will get a hike before the year is out. 

What does that mean for Australia’s housing market? Rismark forecasts imply that with one to two more rate hikes we will get no capital growth, or some small price declines, over the ensuing year. If for some reason the RBA does not raise rates at all, we are projecting inflation-like growth in dwelling values (see two charts below) combined with attractive rental returns.

As we had expected, the latest RP Data-Rismark house price data suggests that Australia’s housing market was finding a base before today’s RBA board meeting. In the month of June, we found that national dwelling values were basically flat (-0.2%). Over the 12 months to end June, Australian home values had retraced by a very modest 2%. 

The chart below shows the year-on-year capital growth returns (excluding rents) for both the combined capital cities index and our “rest of state”, or regional areas, benchmark. The final numbers to the right are the year-to-date results.

While dwelling values have tapered by a small margin, both raw rents and rental yields (i.e., rents expressed as a share of the property’s value) have been expanding quickly. According to the ABS, the dollar value of rents rose at a 4.4% annualised pace in the second quarter, which is well above the overall rate of underlying inflation. The combination of rising rents and softening prices has helped yields to improve, as is illustrated by my next chart. Gross yields for apartments now look to be piercing the 5% threshold.

If you are a household with a lot of mortgage debt, fingers crossed that the RBA decides to ignore its official inflation-targeting responsibilities next month. If, on the other hand, you have prudently accumulated large net cash savings, here’s to hoping it does its job!

Christopher Joye is a leading financial economist and works with Rismark International. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.