The RBA’s critical assumption when raising rates – and the implications of getting it wrong

The RBA’s hawkish approach to interest rates have been the cause of lots of controversy in the last twelve months. While the U.S. Fed has also been hawkishly increasing rates, Australians are likely to feel the impact of rate rises far more quickly compared to a U.S. counterparts as the vast majority of our mortgages are variable rates and U.S. mortgages are fixed thirty year rates.

While unemployment remains low and inflation ticks up, the RBA is relying on an assumption that the savings that Australians have banked during COVID are enough of a buffer to soften the blow of raising rates. Under this assumption, as the RBA cranks its rates up, households do not immediately react by drastically dropping their consumption – rather they go through their savings buffers while slightly reducing consumption.

However, ABS data from 2022 shows that these savings buffers are getting rapidly exhausted. As the household savings / disposable income declined from 8.3 to 6.9% in September. Perhaps the RBA did not forecast the impact that easing the restrictions would have on consumer spending habits – as many Australians spent big in 2022 while prices increased in-tandem.

Moreover, there is a question of how these savings are distributed across households. If the savings are concentrated in high-income / high net worth households already, the effect of the savings buffers on the overall economy will be considerably lower than forecasted. What’s most likely is that these savings buffers are built up in households that have had mortgages for a while and had the chance to build considerable liquidity. The risk factor lies most within the younger generation that have potentially panic-bought into the market during the peaks of 2021 – incentivised by low rates and enabled by quarantine savings.

This is a risk factor that could pose a substantial challenge to the Australian economy. Luckily, lessons from the GFC and high scrutiny on the Big-4 banks has meant that our financial infrastructure should be durable enough to absorb losses. However, as the Australian economy is so heavily reliant on property value – any sign of widespread foreclosures or repossessions will have major implications to the rest of the economy. As of March, Corelogic’s home value index has shown that housing prices are surprisingly resilient – decreasing only by -0.1% in month and -9.1% in year.

If the RBA has over-shot interest rates and is too stubborn to correct, these resilient housing prices may begin to show cracks. Especially in areas where there has been high turnover of properties in peak pandemic years.