Is Australia heading for an interest rate shock in 2022?

Is an interest rate shock coming to Australia? It’s an interesting question for 2022 because an interest rate shock is already here.

In the past month, major banks have hiked fixed-rate mortgages by around 1 per cent. If this were happening in variable rates there would a revolution!

Fixed-rate mortgages have jumped because inflation-panicked global markets have broken the Reserve Bank of Australia’s promise to keep government bond rates nailed to the floor until 2024. When challenged by heavy selling of the bonds, the RBA folded like a house of cards.

By doing this, markets forced up bank funding costs that benchmark fixed-mortgages rates so they rose as well.

Will the same pressures land on variable mortgages next? They could. If global markets continue to panic about inflation, sell off bonds and lift their interest rates, this will eventually force Australian banks to raise variable rate loans regardless of what the RBA does.

And the RBA has just illustrated that it will do what the market tells it to without much of a fight.

Looking ahead to 2022

There are a number of reasons to doubt this outcome for 2022.

The first is that the fixed-rate mortgage hikes we have already seen are much more significant in this cycle than any previous and will trigger material slowing of property prices.

A huge majority of the new mortgage issued in the past two years were the super-cheap fixed-rate mortgages that are now gone. So, with everybody suddenly forced from high-1 per cent mortgages to high-2 per cent mortgages, the property market has been shocked as available credit has shrunk.

There is much more of this ahead. All of the two- and three-year fixed-rate mortgages issued since 2019 will keep resetting to much higher variable interest rates commencing in 2022 and rolling on for three years.

So, consumer confidence is likely to ease next year as house price rises fall back to modest or even some falls. That will weigh on inflation.

The second reason to have confidence that neither the RBA nor banks will push up variable mortgage rates next year can be found in the same bond markets that have shocked fixed-rate mortgages higher. Despite forcing up short-duration interest rates out a few years, markets have also lowered longer-duration yields. This is called a flattening yield curve:

Yield curves flatten when markets are sending the signal that today’s interest rate rises are going to damage growth and inflation in the future. A flattening yield curve describes either a belief that inflation is going to fall away or policymakers are making an error or both.

Importantly, this signal is global so markets are saying very clearly that the 2021 inflation breakout – in the US especially – is temporary.

There are also reasons to think that Australian inflation will be weaker than fading global inflation.

China and global inflation

China is playing a key role in the creation of global inflation via its Covid-stimulus but its property crisis is increasingly playing a role in deflating it, with much more of that ahead for 2022.

The Evergrande panic is over but the hard work of consolidating $10 trillion in toxic developer debt is not. This will weigh on Australia’s key commodity prices all year and denude the economy of a lot of income, also weighing on inflation.

Then there is the resumption of mass immigration and the very powerful role it plays in suppressing local wages growth. Australian wages are currently growing at half the rate of US wages and that gap will probably grow as immigration resumes.

As the RBA has made painfully clear, there will be no cash rate rises until wages growth is well north of 3 per cent and staying there. Immigration will kill that off before it even starts.

Australians will likely not face rate hikes in the year ahead but they might well wonder if they would be better off if they did.

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geopolitics and economics portal. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.