What will interest rates peak at this time ?

[kum yin lau]

Hi, we need to look at stats subjectively as well.

Anecdotal reference go against the notion of high household debt.

People around me, family & friends are mostly debt free. A lot of them [fifties] don't even have a mortgage.

2 have 7 figure fixed deposit that's cash.

In my mind, I'm looking at 10 households.

I'm the only one with 'high' debt of 670 thousand. And the only one a bit cash strapped. But then I stopped working for 5 years already.

KY

 

[TheAnalyst]

Hi, we need to look at stats subjectively as well.

Anecdotal reference go against the notion of high household debt.

People around me, family & friends are mostly debt free. A lot of them [fifties] don't even have a mortgage.

2 have 7 figure fixed deposit that's cash.

In my mind, I'm looking at 10 households.

I'm the only one with 'high' debt of 670 thousand. And the only one a bit cash strapped. But then I stopped working for 5 years already.

KY

So what did you really mean? We are better off than 5 years ago (debt)....

 

[J Martin]

AUSPROP i think you are over reacting. The RBA is learnt a very good lesson from the US about the asymmetric risk of tampering with interest rates.
ie when a country gets into economic difficulty it rapidly reduces interest rates to stimulate the economy, but when the risks of economic difficulty decline there is pressure not to increase the interest rates upwards at the same rate.

Lets take a simple scenario:
Lets assume the RBA leaves interest rates at 3% because inflation at this stage is not a problem.
Gradually the market will adjust to the interest rate of 3%. In the form of residential interest rates and prices lets assume borrowers gradually adjust their ability to buy based on say 10% equity 90% debt on new purchases at an interest rate of say 5% (including bank margins, bank funding costs ect).

Lets say the borrower can 'afford' repayments of $3000 per month. Therefore the affordable market price of a property cuts off at (($36,000/0.05))0.9=$800,000. Im keeping things very simplistic here.
So overtime the underlying demand for property would push the price up to a ceiling of $800,000 if the market believed that 3% RBA rates were sustainable.

Now lets fast forward a few years.
What happens if inflation starts to build. The RBA would be forced to act and increase interest rates, but what would be the effect on the financial system, property owners, and property prices?
If we run the above numbers with an interest rate of 7% to the borrower (ie 2% of interest rate rises), the ceiling price drops to (($36,000/0.07))0.9=$570,000.
Therefore if any borrower defaulted the 'new' borrower would only be able to pay a ceiling price of $570,000, hence a big risk of a property crash and all the financial consequences associated with that.

What happens if inflation doesnt build. Well the market is already 'used' to an RBA interest rate of 3%. The next time an exogenous shock happens to the economy, the RBA would have to drop interest rates below 3%, because the 3% is the new 'norm'.

Eventually we get to the scenario in the US where interest rates are at 'zero' and the Fed is forced to 'buy' debt to keep interest rates low.

The RBA has stated quite clearly that rate settings below 4% were only meant to protect the economy during a period of significant uncertainty and risk. Now that that uncertainty and risk is declining, interest rate settings should adjust accordingly.

Its not because of immediate risk of inflation that interest rates are rising, its to avoid the asymmetric risk associated with keeping interest rates too expansionary for too long.

In the short term increases in interest rates will hamper the potential economic recovery in australia, but over the medium term it will increase the sustainable economic growth rate.

Good post. i've always believed that the design of our economic system inevitably leads to a cash rate of 0 long term for some of the reasons you mentioned. When you target inflation at 2-3%, debt never erodes, and the peak of each cycle becomes lower than the one before due to higher and higher debt levels relative to income. How quickly this occurs is dependent on the decisions of the RB.

It will be interesting to see how the US handles ZIRP.

 

[keithj]

Lets take a simple scenario:
Lets assume the RBA leaves interest rates at 3% because inflation at this stage is not a problem.
Gradually the market will adjust to the interest rate of 3%. In the form of residential interest rates and prices lets assume borrowers gradually adjust their ability to buy based on say 10% equity 90% debt on new purchases at an interest rate of say 5% (including bank margins, bank funding costs ect).

Lets say the borrower can 'afford' repayments of $3000 per month. Therefore the affordable market price of a property cuts off at (($36,000/0.05))0.9=$800,000. Im keeping things very simplistic here.
So overtime the underlying demand for property would push the price up to a ceiling of $800,000 if the market believed that 3% RBA rates were sustainable.

Hi chilliaa,

I know you've said it's simplistic, but I think it's to simplistic to reflect reality. Based on your scenario......

Now lets fast forward a few years.
What happens if inflation starts to build. The RBA would be forced to act and increase interest rates, but what would be the effect on the financial system, property owners, and property prices?
If we run the above numbers with an interest rate of 7% to the borrower (ie 2% of interest rate rises), the ceiling price drops to (($36,000/0.07))0.9=$570,000.

So you're saying that after a few years of inflation, wages ('affordability') has remained at $36,000 ? Surely wages would rise at inflation or higher ?

Assuming a cycle from low inflation (with rates of 5%) to high (with rates of 7%) is 5 yrs. Wage inflation of 4%pa would mean 'affordability' would rise to ~$44,000. So the ceiling price drops to (($44,000/0.07))0.9=$695,000. A long way from $570,000.

And if we assume that discretionary income (& therefore affordability) rises at 6%pa, then the ceiling price only falls to $764,000, so the 40% rise in IRs has made 5% difference to the ceiling price.

Therefore if any borrower defaulted the 'new' borrower would only be able to pay a ceiling price of $570,000, hence a big risk of a property crash and all the financial consequences associated with that.

That's a big assumption. 80% of buyers are NOT FHBs and have a much larger deposit than 10%. So assuming the ceiling price will fall in inverse proportion to a rate rise is unreasonable. Most upgraders have a deposit of ~50%, therefore they aren't paying interest on 50% of their house value, so their affordability (& ceiling price) is affected far less.

However, I'd agree that the affordability & ceiling price for the minority of FHB (with 10% deposit) will fall dramatically as IRs rise dramatically.

In the short term increases in interest rates will hamper the potential economic recovery in australia, but over the medium term it will increase the sustainable economic growth rate.

Agree . Cheers Keith

 

[chilliaa]

Hi chilliaa,

I know you've said it's simplistic, but I think it's to simplistic to reflect reality. Based on your scenario......

So you're saying that after a few years of inflation, wages ('affordability') has remained at $36,000 ? Surely wages would rise at inflation or higher ?

Assuming a cycle from low inflation (with rates of 5%) to high (with rates of 7%) is 5 yrs. Wage inflation of 4%pa would mean 'affordability' would rise to ~$44,000. So the ceiling price drops to (($44,000/0.07))0.9=$695,000. A long way from $570,000.

And if we assume that discretionary income (& therefore affordability) rises at 6%pa, then the ceiling price only falls to $764,000, so the 40% rise in IRs has made 5% difference to the ceiling price.

That's a big assumption. 80% of buyers are NOT FHBs and have a much larger deposit than 10%. So assuming the ceiling price will fall in inverse proportion to a rate rise is unreasonable. Most upgraders have a deposit of ~50%, therefore they aren't paying interest on 50% of their house value, so their affordability (& ceiling price) is affected far less.

However, I'd agree that the affordability & ceiling price for the minority of FHB (with 10% deposit) will fall dramatically as IRs rise dramatically.

Agree . Cheers Keith

You are totally correct Keith, simplicity creates unrealistic scenarios.
And the economy(and property market) is far more complicated.
But i was driving home the basic logic of why the RBA wants to increase rates and the risk of asymmetric risk (this also applies to speculation/consumption in other classes funded by debt as well).

In regards to wage increases, it would depend on the movement of wages over the time frame relative to the increase in interest rates.
If the interest rates were held low and then suddenly ramped hard at the end of the cycle the effect would be similar to the simplistic model above.

In regards to non first home buyers, they would also adjust over time. Their ability to upgrade would still be determined by their repayments (eg 50% equity, now what can i afford to upgrade to?)

 

[willair]

That's what a lot of people miss a very simple simple fact,the cycle never stops,the larger the market capitalisation in any market and there are several different markets out there, property is only one,and the greater the lending ratio into that market will happen in that market because statistics are invisible,imho..willair..

 

[gwk]

While cooling housing is probably the priority, the dollar is also due to impact on our economy in the next few months. Our exporters and their profitibility will be increasingly punished as the interest differentiation between here and other Central Banks widens. Therefore despite the talk, the RBA may pause after reaching "normal" levels to let other countries play "catch up" with their rates.

A higher dollar should also lower the cost of many goods bought and sold in Australia and help moderate inflation I would have thought, at least for a while.

 

[steveadl]

Therefore despite the talk, the RBA may pause after reaching "normal" levels to let other countries play "catch up" with their rates.

But that's sort of the point isn't it? What is the normal level for the fed rate? They're suggesting another 100basis points will bring it back to (more) 'normal.'

 

[josko]

Keith, with respect, what the RBA says and what is does can be two different outcomes.
My feeling is that the RBA is still trying to jawbone by warning that they will increase IR if necessary.
There was a great article by Charlie Aitken about how longer term currency traders should take a hint by following RBA currency trades.

IR are DEFINATELY going up, but to what level?????
The street can make its predictions, but personally, i dont think we will be going to anything above a neutral setting. Not until global economic growth becomes more sustained.

This is my opinion too. You make such good sense Chillia.

Regards JO

 

[keithj]

Keith, with respect, what the RBA says and what is does can be two different outcomes.

Absolutely.

My feeling is that the RBA is still trying to jawbone by warning that they will increase IR if necessary.

I feel they are deadly serious. The current emergency levels were justified 6 months ago, but not any more. They are looking forward at a potentially serious inflation problem. In their recent statement they forecast core inflation to not fall to within the 2-3% band any time soon. All surveys & leading indicators show confidence & forecast conditions to be strongly improving. I don't feel that jawboning will have any effect until rates get back above neutral (whatever that is these days? 5%?).

IR are DEFINATELY going up, but to what level?????
The street can make its predictions, but personally, i dont think we will be going to anything above a neutral setting. Not until global economic growth becomes more sustained.

I think global economic growth is less important that China growth, which is back to boom time levels.

I voted 8% by end of 2010, with discounted rates in lowish 7's.

 

[josko]

Oh boy,

The impact on rates rising that fast would have such a detrimental effect.

I can see 7.5%, but 8% so quickly just doesn't sit well on the whole economic/recovery/confidence outlook to me.

Remember, when Interest Rates were around 8% in 2008, people were locking them in at a frantic pace. The sky was falling.

I believe rates ARE too low and this rate rise and maybe the next few are to reign Consumers in and give everyone a reality check.

These rate rises are precautionary measures.

The RBA: "See what we can do if you're really bad?"

Regards JO

 

[DeeHwa]

Oh boy,

The impact on rates rising that fast would have such a detrimental effect.

I can see 7.5%, but 8% so quickly just doesn't sit well on the whole economic/recovery/confidence outlook to me.

Remember, when Interest Rates were around 8% in 2008, people were locking them in at a frantic pace. The sky was falling.

I believe rates ARE too low and this rate rise and maybe the next few are to reign Consumers in and give everyone a reality check.

These rate rises are precautionary measures.

The RBA: "See what we can do if you're really bad?"

Regards JO

We may get into a situation where rate rises actually exacerbate the supply shortage of properties given higher financing costs and thus, delays in development projects.

I work in the property and construction consultancy sector and I can tell you that residential developments are still quite fragile and thin (probably going to get worst). What is propping up work for us (and other consultancies, builders, subbies etc.) is definitely public sector projects like schools, hospitals, infrastructure, economic stimulus projects etc.. However, it is not like people can live in schools, hospitals and on roads right? hahahaha...

I always hear people predicting that the market is going to slump next year, and maybe it will (who knows exactly for sure if and when) but have these very same people considered whether they would be able to afford the depressed property prices anyway (if property prices do drop)? They would most likely be borrowing at exponentially higher rates than today and credit would be even more tightened if banks have a genuine fear that the mortgage-backed security is not that safe after all. The combination of higher interest rates and drop in property prices would only further fuel the supply shortages as developers would throw in the towel and call it a day.

Ok, to answer the original question, I think interest rates have a fair bit to go...don't want to make a % prediction because I haven't given that much thought to it. hahaha...

 

[keithj]

The impact on rates rising that fast would have such a detrimental effect.

I can see 7.5%, but 8% so quickly just doesn't sit well on the whole economic/recovery/confidence outlook to me.

Remember, when Interest Rates were around 8% in 2008, people were locking them in at a frantic pace. The sky was falling.

To put 2008 into perspective this is the RBA cash rate for the last 20 years.

The cash rate hit 7.25% in March 2008 & stayed there till Sept. A cash rate of 5% by end of 2010 is still far below that and will probably be seen as still stimulatory. Bank margins have increased, so a SVR of 8% isn't out of the question.

I believe rates ARE too low and this rate rise and maybe the next few are to reign Consumers in and give everyone a reality check.

These rate rises are precautionary measures.

Absolutely. Nearly everyone withstood an SVR of 9.5% in late 2008 - discounted variable loans were 8.85%. Rates ~1.5% below those shouldn't be to much of a problem.

 

[josko]

Food for thought. ANZ have just changed their Fixed.

Up we go guys. Where it stops- no body knows.


ANZ Residential 1 Year Fixed Rate Home Loan & RIL 5.70% 6.50% +0.80%
ANZ Residential 2 Year Fixed Rate Home Loan & RIL 6.69% 7.34% +0.65%
ANZ Residential 3 Year Fixed Rate Home Loan & RIL 7.09% 7.69% +0.60%
ANZ Residential 4 Year Fixed Rate Home Loan & RIL 7.69% 7.94% +0.25%



Regards JO

 

[josko]

We may get into a situation where rate rises actually exacerbate the supply shortage of properties given higher financing costs and thus, delays in development projects.

I work in the property and construction consultancy sector and I can tell you that residential developments are still quite fragile and thin (probably going to get worst). What is propping up work for us (and other consultancies, builders, subbies etc.) is definitely public sector projects like schools, hospitals, infrastructure, economic stimulus projects etc.. However, it is not like people can live in schools, hospitals and on roads right? hahahaha...

I always hear people predicting that the market is going to slump next year, and maybe it will (who knows exactly for sure if and when) but have these very same people considered whether they would be able to afford the depressed property prices anyway (if property prices do drop)? They would most likely be borrowing at exponentially higher rates than today and credit would be even more tightened if banks have a genuine fear that the mortgage-backed security is not that safe after all. The combination of higher interest rates and drop in property prices would only further fuel the supply shortages as developers would throw in the towel and call it a day.

Ok, to answer the original question, I think interest rates have a fair bit to go...don't want to make a % prediction because I haven't given that much thought to it. hahaha...

NSW will suffer also. I also know a few Developers and the general outlook is very shaky. There is alot of uneasiness and uncertainty.

With so many unknown factors thrown in:

1. Rising Interest Rates.
2. Changes to the Tax System.
3. An economy in recovery.
4. High Aus Dollar.
5. Tightened Credit- ESPECIALLY for developers.

It is a tough call.

Regards JO

 

[josko]

To put 2008 into perspective this is the RBA cash rate for the last 20 years.

The cash rate hit 7.25% in March 2008 & stayed there till Sept. A cash rate of 5% by end of 2010 is still far below that and will probably be seen as still stimulatory. Bank margins have increased, so a SVR of 8% isn't out of the question.

Absolutely. Nearly everyone withstood an SVR of 9.5% in late 2008 - discounted variable loans were 8.85%. Rates ~1.5% below those shouldn't be to much of a problem.

I agree then, that 8% isn't out of the question but I just see it as unlikely. Yes, I know what the Cash Rate has been and I know what the averages have been but we are in an unprecedented situation with a World Economy coming out of a recession.

We have had both the Stock Market crash and the Property Market Crash at the same time.

95% of the Population listen to the news and media and take the sensationalism to be fact. Regardless of whether it is or not, when you have someone yelling the same thing at you morning and night, you start to believe it. If Interest Rates rise consecutively for the next 12 months, can you imagine the media?


Australia was in such a superior position with China fueling inflation as the Pot of Gold at the end of the Rainbow. It took a huge shock and therefore a considerable rise in IR to kerb spending. Not to mention the Credit Crisis.

This time, I don't consider the shock will need to be so bad. We have a higher unemployment situation now, low business confidence, a building and construction ebb/decline due to factors mentioned above and a more wary nation. I hope.

Then again, I think you and I are debating over .25%. (High 7's Vrsus 8%). LOL

Regards JO

 

[TheAnalyst]

To put 2008 into perspective this is the RBA cash rate for the last 20 years.

The cash rate hit 7.25% in March 2008 & stayed there till Sept. A cash rate of 5% by end of 2010 is still far below that and will probably be seen as still stimulatory. Bank margins have increased, so a SVR of 8% isn't out of the question.

Absolutely. Nearly everyone withstood an SVR of 9.5% in late 2008 - discounted variable loans were 8.85%. Rates ~1.5% below those shouldn't be to much of a problem.

Hi Keith,

Do you have all the data back to 1980 on cash rate? tahnks

 

[TheAnalyst]

Just read RBA data. It makes me think Nov will be at least 0.5% increase. RBA has the tradition to cut rate fast an rise fast. The cash rate will be quickly get 5 or 6 next year. I predict 4% by Christmas and 6% by mid next year.

Cash Rate Target


Effective Date Change in cash rate New cash rate target
(Per cent) (Per cent)
7-Oct-09 0.25 3.25
8-Apr-09 -0.25 3
4-Feb-09 -1 3.25
3-Dec-08 -1 4.25
5-Nov-08 -0.75 5.25
8-Oct-08 -1 6
3-Sep-08 -0.25 7
5-Mar-08 0.25 7.25
6-Feb-08 0.25 7
7-Nov-07 0.25 6.75
8-Aug-07 0.25 6.5
8-Nov-06 0.25 6.25
2-Aug-06 0.25 6
3-May-06 0.25 5.75
2-Mar-05 0.25 5.5
3-Dec-03 0.25 5.25
5-Nov-03 0.25 5
5-Jun-02 0.25 4.75
8-May-02 0.25 4.5
5-Dec-01 -0.25 4.25
3-Oct-01 -0.25 4.5
5-Sep-01 -0.25 4.75
4-Apr-01 -0.5 5
7-Mar-01 -0.25 5.5
7-Feb-01 -0.5 5.75
2-Aug-00 0.25 6.25
3-May-00 0.25 6
5-Apr-00 0.25 5.75
2-Feb-00 0.5 5.5
3-Nov-99 0.25 5
2-Dec-98 -0.25 4.75
30-Jul-97 -0.5 5
23-May-97 -0.5 5.5
11-Dec-96 -0.5 6
6-Nov-96 -0.5 6.5
31-Jul-96 -0.5 7
14-Dec-94 1 7.5
24-Oct-94 1 6.5
17-Aug-94 0.75 5.5
30-Jul-93 -0.5 4.75
23-Mar-93 -0.5 5.25
8-Jul-92 -0.75 5.75
6-May-92 -1 6.5
8-Jan-92 -1 7.5
6-Nov-91 -1 8.5
3-Sep-91 -1 9.5
16-May-91 -1 10.5
4-Apr-91 -0.5 11.5
18-Dec-90 -1 12
15-Oct-90 -1 13
2-Aug-90 -1 14
4-Apr-90 -1.00 to -1.50 15.00 to 15.50
15 Feb 1990 -0.50 16.50 to 17.00
23 Jan 1990 -0.50 to -1.00 17.00 to 17.50

 

[Alex P Keaton]

Food for thought. ANZ have just changed their Fixed.

Up we go guys. Where it stops- no body knows.


ANZ Residential 1 Year Fixed Rate Home Loan & RIL 5.70% 6.50% +0.80%
ANZ Residential 2 Year Fixed Rate Home Loan & RIL 6.69% 7.34% +0.65%
ANZ Residential 3 Year Fixed Rate Home Loan & RIL 7.09% 7.69% +0.60%
ANZ Residential 4 Year Fixed Rate Home Loan & RIL 7.69% 7.94% +0.25%


Regards JO

oh crap, i hope my mb faxed my papers through to anz before the rate changed!! I hope I do get the 3 year fixed at 7.09 %.

Dammmmm ANZ arrgh


Product BreakFree Package Fixed 3 Year (IO)
Amount $199,000
Term 30 Years
Interest Only Term 3 Years
Interest Rate 7.09% pa
Repayments $1,176 per month

 

[Alex P Keaton]

Food for thought. ANZ have just changed their Fixed.

Up we go guys. Where it stops- no body knows.


ANZ Residential 1 Year Fixed Rate Home Loan & RIL 5.70% 6.50% +0.80%
ANZ Residential 2 Year Fixed Rate Home Loan & RIL 6.69% 7.34% +0.65%
ANZ Residential 3 Year Fixed Rate Home Loan & RIL 7.09% 7.69% +0.60%
ANZ Residential 4 Year Fixed Rate Home Loan & RIL 7.69% 7.94% +0.25%



Regards JO

when does it start? today?