Mortgage rates could rise on back of high global rates

Updated

As record runs go, it barely raised an eyebrow.

When there's so much happening — cricket scandals, trade wars and the potential for military action — ongoing inaction generally isn't a celebrated event.

Last Tuesday, the Reserve Bank of Australia distinguished itself for equalling its record of 20 consecutive months of doing nothing. Next month will be the clincher.

For anyone lulled into a sense of torpor, best not get too comfortable. Official rates may not be going anywhere any time soon, at least in Australia.

But tremors are roiling through global money markets that will flow directly through to higher domestic rates.

Given the lethargic state of the Australian economy, if the Reserve Bank is going to be forced into action, it's more likely that its next move will be to lower the official rate, just to counter the impact of higher global rates on an economy that's mortgaged to the hilt.

What is driving the rate rise?

Last September, in one of her final outings as head of the world's biggest central bank, Janet Yellen announced that it finally was time to begin unwinding the great monetary stimulus that has propped up the global economy for much of the past decade.

While Wall Street, obsessed by official interest rate movements, largely chose to ignore the announcement, the great stimulus unwinding was a far more profound development.

Since the financial crisis, the US Federal Reserve has pumped more than $US3.5 trillion into the US economy — a large portion of which washed around the globe — via a process known in polite circles as Quantitative Easing. But let's just call it what it is: money printing.

When combined with official rate cuts down to zero, it pushed market rates to their lowest levels in human history, the final sprint in a 30-year run of declining interest rates.

The effect? It was supposed to spur investment and employment. Instead, it helped inflate asset prices around the globe, everything from real estate to share markets and beyond.

No-one, it seems, has given much thought as to what may happen once the process is reversed. As of October, the Fed began pulling $10 billion each month out of the system.

On the surface, the amount appears almost insignificant, particularly against the Fed's total debt of $US4.5 trillion.

But the process already is having an impact, particularly on short-term market rates, which have pushed higher since January.

Removing cash from the system creates a relative shortage which, just like any commodity, forces the price higher.

When it comes to cash, the price we're talking about is the rate.

It's not the only factor lighting a fire under global rates. Donald Trump's tax cuts have seen multinationals repatriating cash, creating US dollar shortages in some markets.

Then there is the escalating trade war between the US and China which is causing US dollars to rush for the safety of home. Perversely, that may push rates down in the short term as capital floods into US government bonds.

On the domestic front, the Hayne Royal Commission has begun to cast a pall over the banks, exposing years of reckless management, excessive risk taking and lax lending standards.

That can only mean one thing. Loans will be more difficult to obtain in the future. Potential borrowers are likely to find their bank either unwilling to lend as much as previously, if at all.

How soon before this hits us?

That's difficult to answer with any precision. But higher rates offshore will ripple through our financial system because our banks have borrowed heavily in wholesale debt markets offshore.

Royal Commission or not, they won't hesitate to lift mortgage rates if their wholesale funding costs rise.

Since the financial crisis, our banks have worked hard at conditioning us to discard the notion that only the Reserve Bank is the only body with the power to shift our interest rates.

Remember those out-of-cycle hikes? Or the banks' refusal to pass on the full official rate cuts during the darkest days of the crisis?

And last year, when the banking regulator, the Australian Prudential Regulatory Authority, clamped down on investor interest-only loans, the banks decided to restrict them by raising the price, or the interest rate.

While Reserve Bank governor Philip Lowe kept rates on hold last week, he dropped a clanger, noting a market squeeze driving US rates already was being felt here.

"There has … been some tightening of conditions in US dollar short term money markets with US dollar short term interest rates increasing for reasons other than the increase in the federal funds rate," he said.

"This has flowed through to higher short-term interest rates in a few other countries including Australia."

Will housing be affected?

The short answer is yes.

If rate cuts and stimulus drove prices higher, it's not too much of a stretch to imagine the impact on asset markets once official and market rates head north.

Capital city real estate already has begun to stagnate after six years of frenetic gains.

Sydney prices have fallen 2.1 per cent in the past year, Melbourne marked time over the past quarter with Hobart the only major centre still roaring ahead.

That's largely due to the handbrake being applied by regulators such as APRA and the Reserve Bank over high-risk lending.

A rate hike would put enormous pressure on those who have borrowed to buy real estate at or near the top of the market.

Not only would their ability to maintain repayments be affected, higher rates would accelerate price declines which may see many with mortgages that outstrip their property value.

Property and foreign debt - a volatile mix

As a nation, we now have more than $1 trillion in net foreign debt, almost a tenfold lift since 1990. The vast bulk of that is money our banks have borrowed offshore.

Many economists dismiss the idea that we have a foreign debt problem, arguing the money has been used to fund investments that have made the nation a much wealthier place.

That's true. The only problem is that by far the biggest investment has been in housing.

Our banks have borrowed around $700 billion on offshore markets and watched on in glee as we've ploughed that into real estate, pushing prices to the heavens, forcing new entrants to borrow even more.

Between them, the big four banks hold about 80 per cent of all Australian mortgages. Real estate has become their dominant business, comprising up to 60 per cent of their total loan books.

Those vastly inflated real estate values may have pumped up national wealth. But the downside is that our household debt is at extremely worrying levels. At close to 200 per cent of annual household income, it's among the world's highest.

So stretched are household budgets, any kind of interest rate hike would see consumption, by far the biggest driver of our economy, slashed. Add in a spike in bad debts and bank profits would be hammered.

With inflation persistently below trend levels and anaemic wages growth, the Reserve Bank simply cannot afford for household spending to take a hit.

If we do see our banks pushing the button on a series of mortgage hikes in coming months, the RBA will have no option but to hack into its already record low of 1.5 per cent just to keep the economy on track.

So much for records.

Topics: business-economics-and-finance, industry, consumer-finance, international-financial-institutions, government-and-politics, housing, banking, economic-trends, australia, united-states

First posted