Australia’s biggest mortgage lender is warning that if financial markets are right that the Reserve Bank of Australia is set to raise official interest rates to around 2.50% over the next 15 months, it will push the cost of servicing a home loan to record levels.

Gareth Aird, head of Australian Economics at Commonwealth Bank of Australia doesn’t believe it will come to that, noting that the RBA says it’s planning to raise the official cash rate only to a peak of 1.25%, having commenced raising interest rates in June this year.

“It is possible, however, that the RBA takes policy into contractionary territory; either intentionally to put downward pressure on inflation or inadvertently if the RBA’s assessment of the neutral is higher than ours, ” Mr. Aird said.

CBA research indicates that a cash rate of 2.50% would be “deeply contractionary” and would result in mortgage payments as a share of household disposable income rising to a record high, he said.

While CBA is forecasting the worst will be avoided, financial markets are betting that the RBA will take the cash rate to 2.5% by June next year, from a record low of 0.10% now, as consumer prices threaten to rise at a pace not seen since the 1980s.

Worse still, the financial markets have the cash rate going to a peak of 3% over the next two years.

RBA Governor Philip Lowe recently abandoned his earlier guidance that a rise in interest rates could be held back until 2024. He now says an interest rate rise this year is “plausible.”

There has been a strong shift among economists toward the idea the RBA will raise interest rates midyear if the next set of inflation and wage data show consumer prices have jumped.

Mr. Aird said the Australian government’s budget for the year to June 30, 2023 on Tuesday, will help to determine how soon and by how far the RBA raises interest rates.

If fiscal settings remain too loose, the likelihood is that the RBA will need to work harder over time to contain inflation, he said.

“Looser fiscal policy than we currently anticipate increases the probability that the RBA takes the cash rate to a contractionary setting, ” Mr. Aird said.

Source : Market Watch