Rate hike ‘plausible’ in 2022 – what it means for borrowers

If borrowers hadn’t already been preparing for higher interest rates, time is running out to do so.

The governor of the Reserve Bank of Australia, Philip Lowe, now concedes a cash rate rise this year is “plausible”.

The RBA governor has conceded a 2022 rate hike is plausible. Picture: Getty.

It comes just six weeks after Mr Lowe said the conditions for an increase in the cash rate “will not be met” in 2022.

So, why the shift? Put simply, Australia’s economy is performing much better than expected, prompting the RBA to update its economic forecasts.

In a speech to the National Press Club this month, Mr Lowe said borrowers should be preparing now for higher interest rates.

“Interest rates will go up, and the stronger the economy, the better progress on unemployment, the faster and the sooner the increase in interest rates will be,” he said.

“We need to be prepared for that and people need to have buffers.”

What happened to 2024?

During the pandemic, the RBA has repeatedly told borrowers it won’t raise the cash rate until actual inflation is sustainably within the 2% to 3% target range.

For the majority of 2021, Mr Lowe said this wasn’t expected to happen until 2024 “at the earliest”.

While conceding the change in guidance may have damaged the RBA’s credibility in some people’s eyes, Mr Lowe said the 2024 guidance had not constituted a promise.

“We said based on these forecasts, we don’t think that they will. But then the outlook changed, and then the outlook for interest rates changed.

“The result of that might be damaged credibility for the central bank but I hope people can see the fact that the economy evolves in unexpected ways and we respond to it and actually, this is good news, and I’m hoping we get further good years over the course of this year.”

Mr Lowe said if the economy continues to progress towards full employment and sustainable inflation, the RBA would be able to begin raising rates.

So, what does this mean for borrowers?

Interest rates will rise. As for exactly when they will go up, even the experts can’t agree.

PropTrack economist Paul Ryan said a November 2022 rate hike is possible, although he still anticipates the RBA would hold until early 2023.

“There is a lot more uncertainty in the economy now than pre COVID and the RBA is rightly responding to that by being a bit more circumspect and considering more data before making decisions on the cash rate,” Mr Ryan said.

Economists at the big four banks expect a rate hike much sooner, with Westpac and CBA tipping the first rate hike to occur in August this year, followed by ANZ in September, and NAB in November.

Canstar’s finance expert, Steve Mickenbecker, also predicts a rate increase this year.

“I think it is a lot more than plausible, I think it’s likely that we’ll see an interest rate increase at the end of, probably the last quarter of 2022,” Mr Mickenbecker said.

“Inflation’s taking off, full employment is almost reached… I just think it’s a lot more than plausible.”

A ‘shock’ for mortgage holders

It’s been more than a decade since borrowers last saw the cash rate rise.

“There’s a whole generation of borrowers who’ve never seen interest rate increases,” Mr Mickenbecker said.

“So a whole group of people are going to be shocked at the impact of it.”

Mr Mickenbecker says historically rate increases come in clusters, and that might be what catches some borrowers off-guard.

“Normally you’ll get, within 18 months or two years of the first interest rate increase, you’ll get increases that total about 1.5% to 2%,” he said.

And, of course, when the cash rate rises banks will pass that on.

Canstar released modelling based on Westpac’s updated forecast, which anticipates a rate rise as early as August, and rates to peak at 1.75%.

“We’ve modelled that a 1.65% increase increases repayments on a $500,000 loan by $471 a month,” Mr Mickenbecker said.

And with the cost of property surging over 2021, it’s likely any new home owners have substantially more debt than what’s been modelled.

Mr Mickenbecker says if mortgage holders haven’t already started making the most of low interest rates and creating a financial buffer they really need to start now.

While buffers are ideal, Mr Ryan said recent borrowers should be able to withstand higher mortgage costs, particularly since the banking regulator APRA increased the minimum serviceability buffer banks must use when assessing a loan application.

“At the moment someone taking out a loan has to be able to make repayments on that loan at three percentage points above the current rate,” Mr Ryan explained.

“So anyone who took out a mortgage recently should be able to make payments on that loan if interest rates go up by three percentage points, under the same income circumstances.”

New buyers to borrow less

It has never been cheaper to borrow money, but that too is set to end.

Rate increases will inevitably mean more of a buyer’s income will be chewed up on interest.

Canstar analysis shows a person earning the median annual income of $77,900 could borrow up to $459,000 based on the current average variable interest rate of 3.04%.

If interest rates go up by 1.65% that same person would only be able to borrow $388,000, a difference of $71,000.

Shopping around for the best interest rates to minimise the financial pain will be more crucial than ever.

The economic factors at play

The RBA considers a range of economic insights when determining the path for interest rates, including economic growth, the cost of living and jobs and wages.

Mr Lowe said he’s optimistic about Australia’s prospects.

“Our economy has weathered the pandemic much better than was expected, jobs growth is strong and unemployment is low, household and business balance sheets are generally in good shape and wages growth is picking up,” Mr Lowe said.

Here’s how the RBA expects the economy to track over the next couple of years.

Gross Domestic Product

Our economy fared significantly better than the RBA expected in 2021, bouncing back after the numerous lockdowns due to the Delta variant.

The forecast was for Australia’s GDP to grow by 3.5% last year, instead the RBA expects growth was likely around 5%.

And the RBA says the impact on spending during the current Omicron outbreak has been relatively small.

“The worst of the disruptive economic effects from Omicron now appear to be behind us, with supply chain and workforce management problems gradually being addressed,” Mr Lowe said.

“As case numbers trend lower, we expect a strong bounce-back over the months ahead.”

So for this year, the board of the Reserve Bank now expects Australia’s GDP to grow by 4.25% and around 2% over 2023.

Employment

Australia’s unemployment rate also declined earlier than the RBA had anticipated over 2021, and the good news is it’s expected to keep falling.

By the end of the year the unemployment rate is now expected to decline to 3.75% and stay there during 2023.

“If this comes to pass, it would be a significant achievement,” said Mr Lowe.

“Australia has not experienced unemployment rates this low in the past half century – the last time we had the unemployment rate below 4 per cent was in the early 1970s.”

Inflation

The unexpected strength of the economy and disruptions to supply chains has meant an increase in inflation.

The RBA singled out the increased cost of building new homes (up 7.5%) as just one of the key spends boosting headline inflation.

“Looking ahead, we expect underlying inflation to increase further over coming quarters, largely reflecting the ongoing difficulties on the supply side, including currently from Omicron,” Mr Lowe said.

“As these problems are resolved, some moderation in inflation is expected.”

The central forecast is for underlying inflation to be around 2.75% by the end of this year and next.

Wages

Wages growth has picked up, but just to where it was before the pandemic.

Thankfully, the forecast is for the Wage Price Index to grow further, by 2.75% per cent this year and 3% over 2023.