RBA monitoring arrears on the path to lower inflation

On Wednesday (7 June), the Reserve Bank of Australia (RBA) governor Philip Lowe addressed the Morgan Stanley 5th Australia Summit and outlined the RBA must navigate a “narrow path” on the way back to the target of 2-3 per cent inflation.

The speech came a day after the RBA board made the decision to raise the official cash rate by 25 bps, taking it to 4.1 per cent from 3.85 per cent.

The central bank flagged that further tightening may be needed.

One of the considerations Mr Lowe said the Reserve Bank will be looking at is the strength of household spending, with one of the indicators being monitored being mortgage arrears.

“These remain very low, although they have increased a little of late. Banks report that their customers are managing to make their mortgage payments, although many have had to cut back on other spending. So, it is a complicated picture,” Mr Lowe stated.

According to Mr Lowe, real incomes in households have declined, and the required share of household disposable income for mortgage repayments will reach record levels later on this year.

“Many households will transition from low fixed-rate loans over the next few months and experience the increase in repayments that has been occurring for variable-rate borrowers,” Mr Lowe said.

Indeed, the latest data from credit ratings agency S&P Global Ratings has indicated that mortgage arrears in Australia are slowly rising as borrowers face increasing financial challenges.

S&P’s quarterly market overview for March 2023 revealed a rise in both prime and non-conforming mortgage arrears during the first quarter of the year, with prime mortgage arrears reaching 0.95 per cent during this period, approaching the long-term average above 1 per cent.

This was an increase from 0.76 per cent in December 2022 and 0.65 per cent in November of the same year.

Non-conforming loans also experienced a rise in arrears, reaching 3.70 per cent in March, up from 3.20 per cent in December 2022.

Are higher rates working as intended?

Mr Lowe acknowledged that had the RBA not lifted interest rates as it has done, several households may have avoided financial pressures associated with higher mortgage repayments in the short term.

“But this short-term gain would have been at a much higher medium-term cost. If we had not tightened monetary policy, the cost of living would be higher for longer,” Mr Lowe added.

“This would hurt all Australians and the functioning of our economy and would ultimately require even higher interest rates to bring inflation back down.

“So, as difficult as it is, the rise in interest rates is necessary to bring inflation back to target in a reasonable time frame.”

The RBA governor stated higher rates are evidently working and that inflation is coming down, despite the unexpected lift in April.

“The March quarter CPI confirmed that inflation peaked late last year at 7.8 per cent. Subsequent to this, the monthly CPI indicator showed a pickup in the 12-month-ended inflation rate in April to 6.8 per cent,” Mr Lowe said.

“This was a higher outcome than expected, but it has not changed our assessment that inflation is trending lower.”

Rising house prices may necessitate further tightening

Following the 6 June monetary policy meeting, Mr Lowe stated that some further tightening of monetary policy “may be required” in order to guarantee inflation returns to target in “a reasonable time frame”.

“The combination of higher interest rates and cost-of-living pressures is leading to a substantial slowing in household spending,” he said.

“Housing prices are rising again and some households have substantial savings buffers, although others are experiencing a painful squeeze on their finances.”

National home values have now increased for three consecutive months, with CoreLogic reporting a 1.2 per cent increase in May preceded by a 0.5 per cent rise in April and a 0.6 per cent increase in March.

In his speech yesterday, Mr Lowe stated: “We felt like we couldn’t just sit idly and say, ‘well, this is just all accidental — it’s all just noise.

“The conclusion we reached was that this represents upside risks to the inflation outlook in Australia.

“We have been prepared to be patient and get inflation back to target but our patience has a limit, and the risks are starting to test these limits,” the RBA governor said.

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