RBA considering smaller rate hike next month

The governor of the Reserve Bank of Australia has signalled the pace of rate hikes could slow as soon as next month, acknowledging many households are in for a ‘difficult time’ in the lead up to Christmas.

Addressing a recent parliamentary economics committee, RBA governor Philip Lowe said the rise in interest rates has been rapid, but said it will take time to see the full effects on households, given the lag between hikes and higher repayments.

“At some point, it will be appropriate to slow the rate of increase in interest rates and the case for doing that becomes stronger as the level of interest rates increases,” Mr Lowe said.

RBA governor Philip Lowe told a parliamentary hearing the pace of rate hikes could soon slow. Picture: Getty.

The RBA has raised the cash rate at its fastest pace in almost three decades, taking it from 0.1% to 2.35% in just five meetings.

But Mr Lowe hinted the days of double-sized 50 basis point hikes may soon be over.

“I think at our next board meeting we’ll be considering whether it’s a 25 basis point increase or a 50 basis point increase,” Mr Lowe said.

“We’re closer to a normal setting now, which means that the case for large adjustments in interest rates is diminished.

“The fact that we’ve raised interest rates quite a lot already increases the strength of the argument for smaller increases going forward.”

While the size of the hikes may shrink, Mr Lowe said interest rates would continue to rise in the months ahead as the RBA battles to get inflation lower.

“As I have said previously, the size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market,” he said.

Consumer prices have jumped 6.1% over the year to June and are expected to peak at 7.75% by the end of the year, RBA forecasts show.

Mr Lowe said a cash rate of between 2.5% and 3.5% could be expected over the longer term.

“I think we’ll cycle around some number between 2.5% and 3.5%,” he said, “and we’ll cycle up and down that with the economic cycle.”

Chance of one more supersized hike

Some economists, however, believe the RBA may have one more extra-large 50 basis point hike in store.

NAB chief economist Alan Oster said Mr Lowe’s comments on the strong labour market signalled inflation is at risk of becoming entrenched.

“Governor Lowe explicitly noted that ‘the general inflation psychology appears to be shifting, it is easier for firms to put their prices up and the public is more accepting of this’,” Mr Oster said.

“To us this is a significant shift and suggests an increased concern that more needs to be done to keep inflation expectations anchored.”

Inflation pressures and a tight labour market could see the RBA deliver one more double-sized rate hike. Picture: Getty

NAB forecasts another 50 basis point increase at the October meeting, followed by a business-as-usual 25 basis point increase in November.

That would take the cash rate to 3.1% by year-end.

“We still expect the RBA to pause the hiking cycle after November to assess the impact of rate hikes taken across 2022 and the evolution of inflation, the labour market, and the economy.”

Mr Oster said a smaller 25 basis-point increase next month was still a ‘live possibility’.

ANZ and Westpac also expect a 50 basis point increase in October, stepping down to 25 basis points from November.

CBA however anticipates a return to 25 basis points next month.

‘Concerning’ time for borrowers

The aggressive pace of rate rises has caught many recent borrowers by surprise, given the RBA had repeatedly said rates were expected to remain at record lows until 2024.

Questioned on the decision to issue this forward guidance, Mr Lowe said it wasn’t a promise, but conceded the language had influenced borrowers in their purchasing decisions.

“The community took the message that interest rates were going to stay low for a long period of time,” he said.

“I know that higher interest rates are unwelcome for many people, especially those who have borrowed large sums over recent times.

“Higher interest rates are putting pressure on households, just at the time that higher petrol prices and grocery bills are squeezing budgets. So it is a difficult and a concerning time for some people.”

The RBA has faced criticism over its guidance that rates weren’t expected to rise until 2024. Picture: Getty

According to Australia’s largest lender, CBA, there is on average a three-month lag between each RBA rate hike and when borrowers on standard variable rate mortgages experience an increase in their loans repayments.

Because of this, the rate hikes so far won’t be fully felt by borrowers until around Christmas.

And that could equate to almost $800 in additional monthly repayments for a borrower who took out an average new home loan of $611,000 in April, when the cash rate was still at a record low of 0.1%.

Here’s a snapshot of how much the combined rate hikes so far are expected to cost borrowers who took out an average sized home loan before the first rate hike in May.

In these calculations, the borrower is assumed to be an owner-occupier paying principal and interest with 30 years remaining on their loan. It assumes an initial average variable interest rate of 2.86%, according to April RBA figure. The calculation does not factor in loan fees and charges, or any principal paid down over time.

The influx of borrowers who locked in a fixed rate during the pandemic won’t see their repayments rise yet but face a steep jump once they reach the end of their fixed terms.

The RBA estimates around 75% of these fixed loans will expire by the end of next year.

“Over recent years, a lot of people took out fixed rate loans,” Mr Lowe said.

“And that was partly because of our communication,” he said. “The fixed rates for three years were very low because our various policy measures.”

“So they were prepared to go and buy property or undertake other investments because they could get fixed rate money for three years.

“We’ll see the other side of that starting next year when those fixed rate loans roll off, but people did no doubt take heed of what we said.”

Borrowers who took out a fixed home loan face a steep jump in repayments when their fixed term ends. Picture: Getty

That ‘other side’ has been labelled the ‘fixed-rate mortgage cliff’ due to the steep increase in mortgage interest repayments these borrowers will face.

For those who locked in ultra-low sub-2% fixed rates, that could mean a doubling – or even tripling – of the interest component of their home loan, if they roll onto their lender’s variable revert rate.

That’s because the standard variable rate is generally higher than the discounted rate offered to new customers.

Analysis conducted using our home loan repayment calculator shows that could add up to tens of thousands of dollars’ in additional interest over a year, just for being complacent.

For example, a borrower who took out a $500,000 home loan with CBA in October 2021, on a 1.99% one-year fixed rate, could see their repayments jump by $1,414 a month – or nearly $17,000 a year – if they rolled onto the bank’s standard variable revert rate of 6.8%.

By comparison, if they refinanced to CBA’s lowest variable rate of 4.29%, repayments would jump by $625 a month, or $7,500 a year – nearly $10,000 less.

The savings would be even more significant if the borrower refinanced to the lowest variable rate on the market.

In the following calculations, the borrower is assumed to be an owner-occupier paying principal and interest with 30 years remaining on their loan. It assumes an initial one-year fixed rate of 1.99%, and CBA lender rates as of October 2022, including the September rate hike. It does not factor in any future rate hikes, loan fees and charges, or any principal paid down over time.

For a $750,000 loan, the difference jumps to more than $14,000 over the course of a year.

The difference is even starker for a borrower with a $1 million mortgage, with the standard variable rate costing nearly $19,000 extra in repayments over a year, compared to CBA’s lowest variable rate.

Whether borrowers are on a variable home loan, or nearing the end of their fixed term, Mortgage Choice chief executive Anthony Waldron said a broker could help them secure a competitive deal.

“When you look at the home loan market right now, there’s a strong case to be made for borrowers to work with their brokers to review their home loans and get a more competitive deal,” Mr Waldron said.

“Many lenders are offering cash backs to entice borrowers to switch and attractive home loan rates for new customers.

“It’s worth chatting to your broker about whether there’s a more competitive home loan out there for you.”