Record low mortgage rates, and an expectation interest rates will remain low for an extended period of time, have played a central role in stoking Australia’s economic recovery and rebound in housing markets.
Although the Australian economic recovery has beaten forecasts and appears to be navigating the exit of fiscal support without much of a hitch so far, the cash rate and short-term mortgage rates are likely to remain at their record lows for an extended period of time. This outlook for persistently low rates is due to an expectation that labour markets won’t tighten sufficiently enough to increase wages growth to a level that supports inflation moving back to the target range of 2-3% until at least 2024.
The annual change in headline inflation was tracking at just 1.1% in March and wages growth was only 1.5% over the year to March.
Although the cash rate is expected to remain at record lows, many lenders have already shifted their longer-term fixed rates marginally higher, reflecting an expectation for a rise in the cost of funding. With the expiry of the RBA’s $200 billion term funding facility at the end of June, we could see further upwards pressure on longer term fixed rates as bank funding costs normalise.
With Australian housing values moving through an eighth consecutive month of growth, reaching new record highs each month in 2021, the RBA is likely to be monitoring housing market trends closely, or more importantly, the lending behaviours that support market activity. The pace of house price appreciation has slowed a little since growth rates hit a 32-year high in March, but with national home values rising 2.2% in May, the pace of capital gains remains unsustainably high.
Together with worsening affordability for those who don’t yet own a home (due to housing prices rising substantially faster than incomes) and higher supply as the surge in dwelling approvals converts to completed housing, an expectation that fixed mortgage rates could edge higher might be another factor that gradually takes some heat out of the housing market.
In a positive sense, the rapid appreciation in housing values has increased household wealth and has likely been a key contributor to improved spending behaviour that has supported the economic recovery.
However, the recent increase in investor lending and potential for higher household debt could be a source of growing concern, as borrowers stretch their budgets to access the housing market.
In March, the value of investor home lending increased at the fastest rate since July 2003. Investors remain under-represented in the market, comprising approximately 26% of mortgage demand, however if investor activity continues to grow at this pace and first home buyer activity continues to wind down, this segment of the market could quickly rise to above average levels.
Additionally, through the December quarter, the proportion of mortgages issued with high loan-to-income ratios and high debt-to-income ratios increased, as did interest-only loans and loans to borrowers with high loan-to-valuation ratios. Considering the sharper rise in investment lending since the December quarter, it is possible the proportion of these types of loans generally deemed ‘riskier’ has already lifted.
If the RBA, along with the broader Council of Financial Regulators, sees speculative activity rise more materially, or lending standards worsen, there is a strong chance we will see tighter credit controls implemented by APRA. We know from previous rounds of macroprudential policy, tighter credit conditions would likely have an immediate dampening effect on housing market conditions.
Over May, forecasts from the RBNZ signalled interest rates could start trending higher from late 2022. The US central bank has also hinted at a potential to taper quantitative easing down the line. These statements may be viewed as relatively hawkish, and have implications for Australian monetary policy. However, inflation has trended substantially higher in these countries. Additionally, recent events in Melbourne have highlighted the ongoing vulnerability of the economic recovery to COVID-19 outbreaks. Even with COVID well contained and higher levels of vaccinations, any unwinding of the current monetary policy settings is likely to be extremely gradual and carefully communicated, so as not to create a shock to demand.