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Interest Rate Rises and Inflation

With inflation soaring to a 21-year high, a pre-election hike in interest rates could now well be on the cards, experts say. A record low cash rate of 0.1 per cent is clearly now no longer appropriate for this economy, following higher-than-expected inflation figures. Consumer prices climbed 2.1 per cent in the March quarter, taking the annual pace to 5.1 per cent. The CPI recorded its largest quarterly and annual rises since the introduction of the goods and services tax,” said the head of price statistics at the Australian Bureau of Statistics (ABS), Michelle Marquardt. New dwellings (+5.7 per cent) were the biggest contributor to CPI growth in the March quarter, followed by automotive fuel (+11.0 per cent) and tertiary education (+6.3 per cent).

Continued shortages of building supplies and labour, heightened freight costs and ongoing strong demand contributed to price rises for newly built dwellings. Fewer grant payments made this quarter from the federal government’s HomeBuilder program and similar state-based housing construction programs also contributed to the rise,” said Ms Marquardt. The ABS also flagged notable rises across the food group (+2.8 per cent), reflecting high transport, fertiliser, packaging and ingredient costs, as well as COVID-related disruptions and herd restocking due to favourable weather.

Inflation growing ‘twice as fast as wages’

Inflation is now at 5.1 per cent, its highest level since 2001, when the Goods and Services Tax was introduced. Australia Institute chief economist Richard Dennis told Today inflationary pressures meant the chances of the Reserve Bank making the move at their next meeting was now about 50-50. “They are going to increase interest rates, they are going to do it. Whether they do it at the next meeting or the meeting straight after the election, you know, it is as much to do with politics, really, as it is to do with economics,” Mr. Dennis said.

One of the Reserve Bank’s main jobs is to control inflation, to control the cost of living, and what we have just seen is inflation at 5.1 per cent, and that’s twice what wages are growing at. So, real wages in Australia now are falling, because prices are going up so much faster than wages.

May rate hike | Key Points

At its last meeting on 5 April, the RBA board noted that it would be looking at further price and labour costs changes while keeping the cash rate at a record low of 0.1 per cent. But it cannot wait for the March quarter Wage Price Index to be published on 18 May before acting. A rate hike of 0.25 per cent or more could easily be justified in May.

The Reserve Bank has increased interest rates for the first time in more than 11 years, with a 25-basis-point hike taking the cash rate target to 0.35 per cent. The Reserve Bank’s 25-basis-point increase to the cash rate target takes it to 0.35 per cent

The RBA governor warns that getting inflation under control “will require a further lift in interest rates”Financial markets and economists expect the next official rate rise to occur in June

If passed on in full by banks, the rate rise will add $65 a month to repayments on a $500,000 mortgage, and double that on a million-dollar loan. The Commonwealth Bank was the first major bank to respond, raising its standard variable mortgage rates by 25 basis points across the board from May 20, while ANZ will lift rates by the same amount from May 13.

How much the interest rate hike adds to your mortgage repayments*

* Based on a 25 year mortgage

Loan Size

Monthly repayments increase  based on Cash rate of 0.35%

$1 Million$130
$1,250 000$163
$1, 500 000$196
$1, 750,000$228

Borrowers are bracing for a string of rate rises over coming months, as the RBA flagged an improving economy allowing it to end its crisis-era settings. Westpac has forecast a cash rate of 2 per cent by May 2023, which would lift monthly repayments by about $511 for someone with a mortgage of $500,000.

Should you fix your mortgage Interest rates

About a million borrowers have taken out their loans over the past decade, meaning they will never have felt the pinch of a rate hike. For many, it’s a worrying prospect and many are wondering if they should act to fix the interest rate on their mortgage.

Since late last year, banks have been slamming the door shut on their fixed rates below 2 per cent. And they’re still at it. NAB this week hiked its fixed interest rates by another 0.6 percentage points.

Across the big-four banks, 1-year fixed rates are now nudging 3 per cent, 2-year fixed rates are at about 4 per cent and 3, 4 and 5-year rates are well above 4 per cent – hitting 5 per cent in some cases.

As a result, Australians are increasingly jumping off the fixed-rate bandwagon. In a reversion to a more normal state of affairs, the proportion of new loans written with fixed – as opposed to variable – interest rates fell to 28 per cent in February, after hitting a peak of 47 per cent in July last year.

The days for fixing the interest rate, at least at the big four banks, look to be behind us. NAB’s popular three-year fixed rate is now 2.3 percentage points higher than its lowest variable rate.”

Borrowers with a strong aversion to increasing repayments and an expectation of a very high Reserve Bank cash rate in three or so years from now, may still see value in locking in with NAB’s five-year fixed rate, but at 4.99 per cent – 2.8 percentage points above its variable rate – this will be a small minority.

The risk is borrowers may now be paying too much of a premium to fix, compared to what is likely to happen to variable rates. Of course, nobody knows what will happen to variable rates. Most economists are tipping about four official cash rate increases by Christmas, with the rate moving from 0.1 per cent to about 1 per cent by year-end. Depending on whom you ask, they expect the cash rate to climb further to between 1.5 per cent to 2 per cent next year. Financial markets are much more fearful, with futures markets betting the cash rate will hit 3 per cent next year.

Talk to your mortgage broker soon, to get some guidance about what your options are.

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