Further increases in the cash rate will be needed: RBA

The official cash rate is still lower than it needs to be, according to the Reserve Bank of Australia, who maintain households are well-positioned for higher borrowing costs.

Speaking at the Economic Society of Australia, RBA Deputy Governor Michele Bullock said the board needed to find the right balance with interest rates.

“The cash rate target has been increased by 125 basis points since May to 1.35 per cent and the Board expects further increases in the cash rate will be needed in the months ahead,” Ms Bullock said.

“Just how high and how fast the cash rate is raised will depend on many factors, but in making this assessment one of the areas the Board will be closely observing is how households respond to the combination of rising interest rates and prices.”

Ms Bullock said recent borrowers, particularly those who used government programs, were most vulnerable to financial stress bought on by higher borrowing costs.

“Highly indebted households are especially vulnerable in the event of a loss of real income through higher inflation, particularly if combined with rising interest rates, and a decrease in housing prices,” she said.

“Recent borrowers are more vulnerable than earlier cohorts, as they are more likely to have borrowed at high DTIs (debt-to-income ratios), have had their serviceability assessed at lower interest rates (albeit with larger interest rate buffers) and have had less time to accumulate equity and liquidity buffers.”

Ms Bullock also said those borrowers who took out low-interest fixed rates loans could be at risk.

“The majority of currently outstanding fixed-rate loans are due to roll off within the next two years, with the greatest concentration of loans due to expire in the second half of 2023,” she said.

“So these borrowers are shielded for the time being from interest rate rises.

“Assuming all fixed-rate loans roll onto variable mortgage rates and new variable rates are broadly informed by current market pricing, estimates suggest that around half of fixed-rate loans (by number) would face an increase in repayments of at least 40 per cent.”

According to Ms Bullock, despite high levels of debt, households should be able to deal with rising borrowing costs.

“The high level of debt held by Australian households might, on its own, suggest that many households will face difficulties as interest rates rise,” she said.

“While households have high levels of debt, this is accompanied by sizeable holdings of assets.

“Strong growth in housing prices over 2021 and early 2022 has boosted asset values for many homeowners, with housing assets now comprising around half of household assets.

“Furthermore, households have saved a large amount of money since the onset of the pandemic – around $260 billion. 

“These savings have been put into redraw facilities as well as offset and deposit accounts.”

According to the Deputy Governor, large buffers allow households to smooth their spending and maintain required debt payments when faced with lower income or cash flows or higher expenses. 

“If we take these savings into account, the ratio of household credit to income is actually a fair bit lower than the headline figure and is around the same as its 2007 level,” she said.

Ms Bullock said some indebted households will be able to manage easier than others.

“If we look at the households that have debt, almost three-quarters of debt outstanding is held by households in the top 40 per cent of the income distribution; indebted households in the bottom 20 per cent of the income distribution hold less than 5 per cent of the debt,” she said. 

“Furthermore, households with high debt-to-income ratios (DTIs) who might be most affected by a rise in interest rates also tend to be high-income households. 

“Higher income households can typically devote a higher share of their incomes to debt servicing because their other living expenses tend to account for a smaller share of their income. 

“This suggests that a large number of households are likely to be able to handle somewhat higher interest rates.”

According to Ms Bullock, some households are more likely to face financial stress than others. 

“Around one-third of all households have housing debt,” she said.

“This is not to suggest that other households are unaffected by rising interest rates and inflation – clearly there are implications for renters and those who own their homes outright – but indebted households pose more direct potential risks to the financial sector.”

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Rowan Crosby

Rowan Crosby is a freelance journalist specialising in finance and real estate.