Where to from here for interest rates?

The Reserve Bank Board minutes that relate to their meeting in the first week of February make an interesting read if you like to keep up to date on the economic state of play.  The minutes provide a relatively easy to digest synopsis of the factors that are deliberated by the Reserve Bank Board as they decided whether official interest rates should move up, down or sideways.

Of particular interest is how the Reserve board views the housing market.  The Reserve is paying more attention to the private property index providers (including the RP Data – Rismark indices) than the ABS data these days, quoting gains in the residential market of between 10 and 12 percent over the last year (the RP Data – Rismark Hedonic Home Value Indices were reporting a gain of 11.1 percent across the nation’s capital cities).

There is also specific reference to the cooling of ‘affordable’ housing markets due to the pull back of first home buyer demand and the ongoing capital gains that are clearly visible in the more expensive housing markets.  These statements are likely a direct reference to the RP Data – Rismark Stratified Hedonic Home Value index that analyses the market across broad pricing segments:  the most affordable 20% of the market, the middle 60% of the market and the most expensive 20% of the market (see performances of each market segment in the graph below).

 Stratified hedonic home value index

The big question mark that the Reserve Bank minutes leave us with is:  where to from here?  If the financial markets are any indication we are likely to see the cash rate increase by at least 25 more basis points before the end of the financial year.  A 25 basis point rise would bring the cash rate to 4.0% and variable mortgage rates to about 6.9%.  By year’s end the ASX cash rate futures suggest the official cash rate will be about 4.66% which means a variable mortgage rate around 7.5%.

Cash rate futures

That’s quite a bit higher than where mortgage rates bottomed at 5.75% in April/May of last year; but keeping things in perspective, the current mortgage rate is still well below the ten year average.  Over the last ten years interest rates have averaged about 7.25% – so we need to see a bit more than a 50 basis point rise in rates before we meet that long term average. Through all of 2007 and 2008 and the last half of 2006 mortgage rates were higher than this, rates reached a recent peak of  9.6% in July and August of 2008.

Interest rates over time

Despite what may seem like quite high interest rates, the amount of home loans in arrears (more than 90 days overdue) have remained below 0.6% for loans that are well secured by collateral and slightly higher than 0.6% for loans that are not well secured by collateral (have a look at the latest RBA Financial Stability Review where they focus on the measurement of housing arrears here.  In particular, graph B1 shows non-performing housing loans over time).

Without going into further detail, future movements of interest rates are going to be very much dependent on key indicators the Reserve Bank monitors when contemplating interest rates:  Inflation, labour markets, housing prices, retail spending, levels of consumer and business confidence and global and domestic economic conditions.  The minutes certainly leave the door open for more rate rises, however the days of consecutive monthly rate rises are likely to be behind us.

About Tim Lawless

Tim heads up the RP Data research and analytics team, analysing real estate markets, demographics and economic trends across Australia

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