Borrowers should be prepared for further rate hikes

They will be able to continue spending and hit a mortgage pain point if interest rates rise to 4 percent or more. For those without credit or with cash, higher interest rates work in their favor and they have more money to spend. Meanwhile, for a growing cohort of households, higher rates are slowly squeezing their budgets tighter and tighter.

There is also a risk that over-inflating the RBA could become detrimental to economic growth and ultimately have to be reversed. The RBA describes this as the narrow path it walks when assessing where to move interest rates.

While financial markets are betting rates will rise twice (after an assumed March hike) and peak in excess of 4 percent, economists are more ambiguous.

Both will read the statement issued by the RBA carefully for signs of when it might put its foot on the brakes on interest rates, whether the central bank is referring to future rate hikes in the singular or plural, or whether it says future moves will be determined by economic data become.

Westpac chief economist Bill Evans warned Monday of the risks associated with this narrow path.

He pointed to the national accounts for the December quarter, which showed that budgets were under extraordinary pressure. Domestic demand was flat in the quarter, with consumer spending growth slowing to 0.3 percent in the December quarter from 1 percent in the September quarter.

And these lower spending numbers have been recorded even as households are saving less.

The household saving rate fell to 4.5 percent in the December quarter from 7.1 percent in the September quarter. That alone, says Evans, has freed up $9 billion in additional spending capacity.

Despite nominal wage increases, Evans notes that nominal disposable income fell 0.7 percent thanks to a 7.4 percent increase in income tax payments and a 22.4 percent increase in interest rates. Falling real wages (inflation of 7.8 percent in 2022 compared to wage growth of 3.3 percent) contributed to a record (outside the volatile pandemic period) fall in real disposable income of 2.2 percent.

Meanwhile, UBS says rate hikes are now starting to really impact areas like the housing market. In a note to investors Monday, she pointed to “clear evidence of a very sharp correction in the housing market.”

“We believe this is likely to worsen going forward given delays in policy tightening, including the phasing out of fixed-rate mortgages, which will not really accelerate until mid-2023,” the statement said.

The regulator’s decision not to relax the serviceability buffers means that borrowing capacity for housing will continue to fall as interest rates continue to rise.

Against this backdrop, UBS expects house prices to fall by around 17% to 20% this cycle, the sharpest drop on record.