So, the Reserve Bank of Australia (RBA) put rates up for the fifth consecutive month in a row yesterday.
Yes, I know you know that — as do the hundreds of thousands of borrowers across the country.
But it's a helluva thing.
From 0.1% in early May to 2.35% just four short months later.
And that's the 'official cash rate' – you can add a couple of percentage points when it comes to the rate we pay on our mortgages.
Worse, the RBA isn't done. Not, in all probability, by a long shot.
They've said before that 'neutral' is between 2% and 3%. Yes, we're there… but they're not aiming for neutral at this point.
They want to push rates above neutral to pull more spending out of the economy.
They — and most other central banks around the world — want to kill inflation, dead.
And rates are their tool of choice. Because it's the only tool they have.
Why raise rates when people are already struggling with high prices?
Because they're trying to stop those prices going even higher – something that'll almost certainly happen if they do nothing.
And while temporarily higher mortgage rates are painful, they're the 'least worst' option between that and permanently higher prices.
How so?
Try this:
Inflation in the UK is over 10%. With no action here at home, we'd likely see the same thing (and we still might, anyway).
Now, let's assume central banks do nothing, and it stays at double digits for three years.
By 2025, everything would be 33% more expensive (inflation, like interest, compounds!).
And there is no way wage growth could keep up with that.
So, in three short years, your standard of living would be – permanently – one-third lower.
That would be an economic and social disaster.
And one that might take the best part of a generation to resolve.
Kinda makes higher rates look good, at least by comparison, right?
Which is precisely why the RBA is going hard.
They don't want to do it. No one at Reserve Bank HQ is enjoying this or is blind to the very real consequences for some people.
They just have two bad options and are choosing the least-worst.
Such is the economic situation, sometimes.
We just have to hope they get on top of inflation quickly.
Because the quicker they do, the sooner rates can start to come down.
And they will.
No, not to the lows of the last few years – they were 'emergency levels'. But down from the highs we haven't yet reached.
There is light at the end of the tunnel, but it could be a long tunnel. We'll need to buckle up.
Speaking of which, attention is turning to whether or not the current situation needed to be so painful.
We probably couldn't have avoided inflation.
And higher rates are probably the only (and almost certainly the best) solution.
But the pain might have been less.
Perhaps.
I shared a longish thread on Twitter this morning, which got some positive feedback.
I was thinking through the implications of lower rates on house prices which, when the interest rate worm turned (as it was always going to) has become a millstone around the neck of some borrowers.
Here's a summary:
The period between 2010 and 2021 resulted in an explosion in prices, and household indebtedness, thanks to lower rates.
Rate reductions were required, especially post-GFC, but the requirement was, in part, because the government did too little, leaving the RBA to carry the can.
And now it's time to pay the piper for policy failures and straight-out mistakes, some of which were more avoidable than others. Here's what they were, in rough chronological order:
The overarching policy failure: the federal government was gutless, leaving the RBA, too often, as the only adults in the room.
Once a month, they take stock of the data and the policy settings and, like a soccer goalie, try to plug the gaps and clean up the mess
Rates were too low pre-COVID. In part because of that government gutlessness/politicking, and in part because everyone was scared of pushing us back into recession.
Governments wouldn't restore budget structural balance. The RBA wouldn't get back to neutral rates.
And, in 2019, the banking regulator, APRA, inexplicably cut the lending buffer (which requires banks to use a higher-than-current interest rate to qualify borrowers and work out how much they can afford to borrow)!
Then, when rates went down — appropriately, if from too low a level — when COVID hit, government and regulators made the problem worse by not recognising the new low rates were going to suck people in and push prices up.
Or, less generously, not caring (enough).
The RBA's second-biggest mistake was in not seeing inflation coming, even when the signs were clear, overseas. Assuming we were somehow special/immune was frankly silly but, moreover, imprudent when caution was required. An understandable mistake, perhaps, but a bad one.
The bigger mistake? The RBA was very clear in its statement that it didn't intend to raise rates until necessary, and it forecast that those conditions would prevail in 2024.
But… It never promised or said that it wouldn't raise until then. That was a media shorthand mistake, which most people read as gospel.
That said, the RBA failed in its subsequent communications. It had every opportunity to use any and all communication channels to make the point more clearly but chose not to. That meant borrowers were misinformed.
But it wasn't the only body — government or regulator — who could (should!) have acted, by word or deed, to limit the financial risks that homebuyers were unwittingly taking.
Speaking of which, APRA, the banking regulator, finally acted in October last year, increasing the lending buffer by a tiny amount.
It was way too little. And way too late.
The 'buffer' should be used counter-cyclically to dampen house price movements in both directions while letting rate changes impact spending (rather than asset prices).
It truly is a very, very simple solution and would be incredibly effective. Government should have insisted on it. APRA should have implemented it. I don't know what, if any, conversations were had at the time, but they both whiffed it, and borrowers are – quite literally – paying the price.
(A simple example? House prices went up 24% last year. Without that, the young couple with an $800,000 mortgage which is quickly getting much more expensive, would have had a $640,000 mortgage.)
So…
— Government was MIA on policy, and worse was cheerleading the housing boom.
— The RBA missed the opportunities to increase rates pre-COVID, to increase them more quickly as the economy recovered from the COVID shock, and to communicate more clearly.
— APRA made things worse in 2019, then was asleep at the wheel in 2020 and 2021, when borrowers took out seven-figure mortgages at 2% interest rates (and when prices rose 24% in 2021 alone!)
— Banks were happily writing (some) loans that they – and their shareholders may well rue.
Yes, borrowers share the responsibility to some degree. But given the information/sophistication asymmetry, the primary responsibility (and most of the blame) should sit with those who have the regulatory and legislative responsibility to act… and didn't.
But a reminder: The RBA's role is NOT to manage house prices other than as an input into economic growth, inflation and employment.
That responsibility is with government.
And the responsibility for prudent lending is with APRA.
The RBA absolutely should reckon with itself for its failures and mistakes over the past eight or so years.
But if we make that the sole/major focus of review, we not only let others off scot-free, but we don't learn the most important lessons (and will repeat the failures).
In the meantime?
The bad news is that the RBA isn't finished. Probably not by a long shot. Rates could go up another 1% — 1.5%. And, in a worst-case scenario for both inflation and borrowers, perhaps even more.
That will still be better – believe it or not – than letting inflation get away from us.
But much of the damage will have been preventable – and there are many in the halls of power (legislative and regulatory) who should shoulder much of the blame.
