Mortgage holders should brace for short-term pain as RBA signals steady interest rate rises to tackle inflation | Interest rates

Mortgage holders should brace themselves for interest rate rises of at least another 1.15 percentage points before the end of the year as the Reserve Bank of Australia attempts to hose down inflation before it takes hold of the economy.

The RBA governor, Philip Lowe, said he believed inflation was on track to hit 7% by the end of 2022, with an unemployment rate of 3.5% but said the bank was confident inflation would return to the “target range” of between 2% and 3% in a “short while”.

But to do that, the RBA would continue to increase its cash rate, which would spark an increase in retail loan interest rates, as it tried to pull back consumer spending.

In a speech to the Australian Strategic Business Forum in Melbourne on Wednesday (hosted by the Australian newspaper), Lowe said the reserve bank was looking for its “neutral rate” – “the real interest rate that is neither stimulatory nor contractionary”, which he later named as “probably” 2.5%.

That would be an increase of another 1.15 percentage points on top of the 1.25 percentage point increase the reserve bank has already set, which moved the cash rate from the historic low of 0.1% to 1.35% in just three months.

At a separate speech in Brisbane on Tuesday, the RBA deputy governor, Michelle Bullock, said the bank estimated home loans would increase for some mortgage holders by up to $650 a month as their fixed rate loans expired.

Up to 30% of mortgage holders could struggle to keep up with their home loan repayments if interest rates were to increase by three percentage points, Bullock said.

Lowe warned Australians would need to brace for short-term pain as the reserve bank worked to stave off growing inflation, although he conceded next week’s CPI quarterly update release would show inflation had grown from the 5.1% figure calculated in March.

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“Just think of the alternative – if we don’t have higher interest rates, then we’re going to have higher inflation persist, eventually that will have to be addressed and we know how from history that’s addressed,” he said. “It’s addressed through much higher interest rates, not as high as the 17% [in the 1980s], but much higher interest rates and a sharp slowing in the economy.

“So the mindset we have is one of steady increases in interest rates now to forestall a persistent shift in inflation and inflation expectations. And by doing that, we can have a lower peak in interest rates and hopefully avoid the need for a sharp slowing in the expenditure.”

Economist Saul Eslake said the RBA, like other central banks around the world, was drawing on the lessons of the 1970s and 1980s and attempting to nip inflationary mindsets in the bud – that is, the reserve bank was trying to stop increasing inflation from becoming a self-fulfilling prophecy. Much like recessions, if people believe inflation is going to keep going up, they act in ways which ensure it does.

Eslake said psychology was one of the issues the RBA was trying to combat with its rate rises, along with strong consumer demand and labour shortages, and global factors such as Russia’s invasion of Ukraine and supply chain shocks.

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“In the meantime, in the near term, that does imply some pain, especially for those who’ve taken out large mortgages when interest rates were very low, or who are coming off mortgages that were at fixed rates for periods of two or three years,” he said.

“It is better Phil Lowe is saying to take that pain now, then to allow inflationary expectations to become entrenched at a high level thus requiring a good deal more pain to be absorbed by far more people at much greater cost for the down the track.”

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