Wednesday, July 29, 2009

Expect to pay an extra $300 per month on your mortgage

The Australian dollar has soared and financial markets have begun pricing in big interest rate hikes on the back of a declaration by the Reserve Bank Governor that he will soon have to push up rates and that he might do so without waiting for unemployment to stop climbing.

The Bank is thought to have never before pushed up interest rates while unemployment was rising.

But Governor Glenn Stevens told a business audience in Sydney he didn't regard himself bound by such a convention.

"I have never heard nor I have never seen written down a rule of thumb that says we wait until unemployment has peaked before we lift the cash rate," he said.

"It depends what else is happening...

...and also depends how low we went."

"We eased very aggressively which was the right thing to do. Hopefully we'll return to normal in a suitably timely way," he said, adding the economy was recovering sooner than he had expected.

Financial markets immediately priced in an even-money chance of a rate hike by Christmas with futures trading suggesting the cash rate will jump 0.15 percentage points higher by December and 1.50 to 2.00 points throughout next year.

Such a jump would push standard variable mortgage rates back up above 7 per cent and add $300 to the monthly cost of servicing a $300,000 loan.

"Households can afford it," said Macquarie Bank strategist Rory Robertson. "None of them would have taken out a loan expecting these historically low rates to last."

The Australian dollar jumped half a cent on the news, soaring to 83.2 US cents, its highest point for the year and also its highest point since the onset of the financial crisis in September. The share market soared for the eleventh consecutive day.

Some banks remained skeptical about an early move with the ANZ labeling a rate so soon after a downturn "unprecedented and unlikely".

"Any recovery will remain tentative until unemployment stops rising," said economist Riki Polygenis. "And inflation is falling, so there's no inflationary justification for a hike."

Governor Stevens said he had sensed a "tangible improvement in the general sense of Australia's outlook," and that far from being severe, the present downturn might turn out to be "not one of the deeper ones of the post-war period".

"We cannot claim to have avoided any downturn at all, but positive factors have so far outweighed their fears of unemployment," he said. "Housing loan approvals are up by about a third, and house prices are actually tending to rise, with arrears rates remaining very low and in some cases actually falling."

Referring to interest rates Mr Stevens said that in Australia and in other countries it would soon be necessary for authorities such as the Reserve Bank to "remove the exceptional accomodation being supplied at present."

"I am not saying when that is, but in due course that will be required," he said.

"Getting the timing right won't be easy."

The speech was notable for making no reference to the possibility of a further interest rate cut, something that has been canvassed in the formal minutes of each of the last 3 Reserve Bank board meetings.

Mr Stevens said higher interest rates would be needed in to reign in inflationary expectations as the economy recovered and also to ensure strong demand for housing was "translated into more dwellings, not just higher prices."

"This ought to be the time when we can add to the dwelling stock without a major run-up in prices. If we fail to do that – if all we end up with is higher prices and not many more dwellings – then it will be very disappointing, indeed quite disturbing," he said.

"Not only would it confirm that there are serious impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation down the track."

The Governor also said he thought it would soon be time for Australia's banks to wean themselves off the government guarantee and "borrow in their own right, getting back to a world where private risk is appropriatly priced".

Published in today's SMH and Age