The already-record share of income households spend on mortgage repayments will increase even further, the Reserve Bank has warned, causing borrowers to dip into savings to meet the rising cost of living.
Surging home loan repayments were successfully reducing household spending and helping the central bank get inflation back to target, Chris Kent, the RBA’s assistant governor for financial markets, said in a speech yesterday.
But Dr Kent said the RBA would likely respond to any evidence that inflation was not on track to return to the central bank’s 2 per cent to 3 per cent target by December 2025 with another interest rate rise.
“We’ve made it pretty clear we would be not wanting inflation to take much longer,” Dr Kent said, pointing to a significant upward price shock as a potential trigger for a 13th cash rate increase.
The RBA has cited the strength in interest rate pass-through as a reason for leaving the cash rate on hold at 4.1 per cent since June, as the central bank assesses the cumulative effect of its 12 cash rate rises since May 2022.
On Tuesday, International Monetary Fund analysis showed households in Australia devoted a greater share of their income to mortgage repayments than in any other advanced economy.
Dr Kent said scheduled mortgage repayments had risen to almost 10 per cent of disposable income from 7 per cent since the RBA began lifting rates from a record low 0.1 per cent 17 months ago. These figures include households without a home loan.
“This is above estimates of the peak reached in 2008 when the cash rate was 7.25 per cent,” he said.
“And for those households with a large mortgage, required payments are a much higher share of their income.”
The share of household income spent on mortgage repayments will increase further as borrowers on pandemic-era fixed rate mortgages roll off onto variable rates, which are 3 to 4 percentage points higher. The share of fixed rate credit has already fallen substantially to 20 per cent of all home loans from 40 per cent in early 2022, Dr Kent said.
While high interest rates cool the economy, Dr Kent said the main way they slowed demand was by making mortgages more expensive, known as the “cash-flow channel” of monetary policy.
“Many borrowers have had to cut back on spending to meet higher mortgage payments, while also feeling the pain of rapidly rising living costs. This has led to slower growth in demand for goods and services,” he said. Retail sales are in their most prolonged contraction since the global financial crisis, as consumers cut back on purchases of discretionary goods such as furniture and appliances.
The RBA estimates the 4 percentage point increase in the cash rate since May 2022 had reduced overall household spending by about 0.4 per cent to 0.8 per cent per year through the cash-flow channel.
Households accumulated about $300 billion in additional savings during the pandemic, which has provided a cushion to borrowers dealing with rapidly rising interest rates.
However, households had started drawing down on these savings since the start of 2023, RBA analysis shows.
While banks have been under fire for not increasing the deposit rates paid to savers in line with the cash rate, Dr Kent said they had been more generous than their international peers.
Australian banks have passed on about 75 per cent of the 4 percentage point increase in the cash rate since May 2022.
“In New Zealand, for example, the equivalent figure is about 50 per cent, while in the United States it is about 35 per cent.
“Among other things, this difference may reflect Australian banks’ focus on variable-rate borrowing and lending,” Dr Kent said.
Dr Kent pointed to the 30 per cent decline in household borrowing capacity since last year and the support provided to the exchange rate from high interest rates as evidence of the contractionary effects of the most rapid tightening cycle in decades.
