Inevitable wage rises will have role in an inevitable rate hike
It seems an inevitable prolonged surge in wage rises, likely to start before 2023, will contribute to the Reserve Bank of Australia’s (RBA’s) inevitable series of cash rate hikes feared by millions who have mortgages, especially those highly geared on the cheapest loan money in the nation’s history.
But from all that’s been said and written about the RBA and cash rates in recent weeks, the keenest observers have been unable to determine with any worthwhile degree of precision when these rate increases will occur – although Wall Street’s drama of 10 November has increased clarity and lessened uncertainty.
On that day, as the result of the most recent spike in the US inflation rate, the bond market (as distinct from the share market) made mockery of the Federal Reserve’s view that American inflation in recent months was “temporary”. Bond yields had begun soaring and consequently bond prices took a dramatic dive.
[Bond prices move inversely to interest rates and bond yields move in the same direction as rates. As interest rates rise, bond prices decline. If rates decline bond prices will increase. An investor’s current yield will decrease as bond prices increase.]
What’s been happening in the US means mortgage rates in Australia will rise very much sooner than we’ve been led to expect -- irrespective of what the RBA decides to do about the cash rate. Indeed, trying in recent months to figure out what that might be, has been a nightmare for business analysts.
RBA Governor Philip Lowe has, between the running of two Melbourne Cups, made a bewildering array of differing forecasts about Australia’s possible headline and underlying inflation rates that have turned his “promise” of no interest rate rises here before 2024, into a string of maybes – maybe before then, and maybe some time in 2023 depending on what the Fed might do or might not do to curb US inflation, and depending also to what extent inflation in Australia is affected by inevitable wage rises that, according to the RBA, may be only “marginal”.
From certain uncertainty to maybe less
The RBA’s apparent uncertainty is understandable given widespread mystification at the Fed’s denial of obvious American inflation, and worse, according to some critics, its conspiracy with Wall Street to keep the Dow Jones index as low as possible to avoid having to increase interest rates.
But because the US economy is the world’s biggest, whatever happens to it will affect to varying degrees the economies of all other countries. Thus, if the Fed allows inflation to bolt, anything anyone tries to do about consequent inflationary pressures in their countries will be an exercise in futility – like shutting the stable door after the horse has bolted.
The funding of Australian banks depends essentially on borrowing overseas at interest rates based on the price of US bonds, and already we’re beginning to see rising costs of fixed long-term home loan rates in Australia because banks are having to pay more for the loan money they’re borrowing.
And home buyers are not happy at having to pay higher interest rates on their mortgages because of overseas influences while the official cash rate in Australia remains unchanged. But those most heavily mortgaged will be even more unhappy when the RBA makes what prominent economists see as the inevitably necessary decision for the nation’s good to put a brake on inflation, that is to start easing the official cash rate upward from the current historic low of 0.1%.
Wage increases will trigger that brake
When this article was being written the RBA was standing firm on its resolve not to increase that rate until it saw domestic inflation consistent at 3% or higher, and it was maintaining this stance in the belief the economy can accommodate wage rises that won’t necessarily contribute to unacceptable inflation.
Said a farmer friend of the author: “The economy’s got as much chance of being able to do that as me in gum boots kicking a fresh cow pat uphill against a stiff breeze.”
Other Macks Advisory sources express themselves on this issue less colourfully when they point out the RBA’s scenario is unlikely, because Australia is already suffering from a severe shortage of labour across much of the country that is pushing up wages. Costly and dangerous supply chain issues, exacerbated by shenanigans in the shipping industry are hiking the price of importing and exporting goods, and recent increases in Australia’s home building and construction costs are worrying.
Holding wages back in places of massive employment in supermarkets and elsewhere are enterprise agreements negotiated in much more difficult times, not times like these where, boosted by government financial assistance, many substantial businesses are reporting impressive profits.
So, what of the immediate future?
So far there’s been no mass exodus by lowly paid workers to places of greater opportunities and better pay but watch this space for these opportunities are only starting to emerge post pandemic.
A consensus is germinating among analysts there’ll be cash rate increases during next year totalling about 1% with more to come if inflation warrants them.
Less readily answered are questions about the likelihood of these increases causing disruptions in real estate markets and an escalation of bank debts.
Odds are, despite rising building costs, these won’t be catastrophic given a substantial number of people who have mortgages (more than earlier expected) seem likely to be able to continue servicing them, and because high employment rates are expected to continue.
Employed people tend to prioritise maintaining mortgage payments ahead of spending on anything else, and what’s more they’re incentivised to keep doing this because they can see house prices being underpinned by ballooning building costs for new accommodation.
That’s not to say higher interest rates won’t to some extent muffle the house price boom by dampening the enthusiasm of borrowers and giving lenders pause for reflection about who they’ll sign up for mortgages and at what rates.
It’s time to say hello to reality
The reality is the Fed has been AWOL while a basket of products essential to Americans – like Australia’s consumer price index -- has risen by 6.2% from a year ago to hit its highest level in 31 years and has showed no sign of receding as inflation has risen to an annual rate above 10% (way above the Fed’s and the RBA’s stated preference of between 2% and 3%).
Accordingly, the US 10-year bond rate, independent of what was going on in share markets or with central banks’ cash rates that were while the 30-year rate climbed similarly to 1.9%. Therefore, expect Australia’s bond prices to fall sharply, which will boost yields.
Certainly, certainty about even the immediate future of Australia’s cash rate is hard to come by when considering what appears to be the Fed’s dereliction of duty together with other economic influences such as our nation’s consumer revival, booming home and share prices, reopening borders and world-leading COVID-19 vaccination rates.
Furthermore, the RBA’s latest prediction is the economy could grow 12% between now and 2023, and if that were to happen and wages and inflation became elevated, it says “an increase in the cash rate in 2023 could be warranted”. But that’s just more of “could be” or “maybe”.
However, this much is certain. It’s certain that times are ending when a surprising number of businesses have been able to do better because of government stimulus than they were pre-pandemic. Ending too, are times when government stimulus together with temporary legislative changes have assured the survival of zombie businesses, times when loan money will be available at an unprecedently low rates. For as certain as night follows day a time is coming all too soon when imprudent borrowers will suffer because of rate increases.
