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House prices, profits and politics collide in interest rate battlefield

With a Federal election looming and the first signs of pressure on interest rates appearing, the government may soon be locking horns with banks and the Reserve Bank of Australia to keep lending rates at current historic lows.

A blowout in inflation forecasts is a major threat to the Federal Government’s budget outlook, especially if it prompts the RBA to raise interest rates much earlier than its current expectation of 2024 at the earliest.

A subsequent rise in the Australian dollar would only exacerbate the situation by making the country’s exports pricier.

The impact on confidence and household, business and national debt would pose risks for the unfolding economic recovery that could translate as lost votes in an election.

Earlier this year it was expected that October or November were shaping as the most likely months for the first post-COVID-19 federal election, but more recent speculation is that Prime Minister Scott Morrison will wait until 2022 to send Australians back to the polls.

In the latest sign that Australia may soon see the end of ultra-low fixed rates, Commonwealth Bank has just hiked its three-year fixed rate for owner-occupiers.

Australia’s largest bank has increased both its three- and four-year fixed rates for owner-occupiers paying principal and interest by 0.05 per cent, as well as increasing some interest-only loans by 0.10 per cent.

This follows hikes of 0.20 per cent by CBA in March to its four- and five-year fixed rates. CBA now only has one rate under two per cent, which is fixed for two years.

Shams Pathan, Associate Professor of Finance at Curtin University, said the Morrison government would be lobbying hard behind the scenes with the banks and RBA to curtail any significant interest rate rises.

“Australia is doing better than a lot of economies but the government will be doing everything in its power, which is admittedly somewhat limited in this regard, to keeping rates down,” he said.

Funding costs set to rise

Fuelling wider expectations of an interest rate rise is the imminent end of a $200 billion emergency Reserve Bank funding scheme put in place to mitigate the impact of the coronavirus crisis.

It is widely – but not universally – expected to lift fixed mortgage rates from record low levels and dampen soaring demand for housing when it winds up in about six weeks.

Known as the term funding facility, this emergency funding facility was deployed by the RBA during the March 2020 COVID crash to prevent banks from experiencing a credit crunch as the global credit market froze up.

It offered banks money at just 0.1 per cent in place of existing bonds that were much more expensive. The term of this free money was three years. 

But the banks will soon have to refinance with higher-yielding bonds again, with implications for fixed rate mortgages.

RateCity.com.au research director Sally Tindall said CBA was the first major lender to increase its three-year fixed rate from the bank’s record low.

“These rate hikes might be small, but they point to a fixed rate market that’s starting to rise,” she said.

“When CBA hiked its four-year rate in March, a flurry of lenders followed in its wake and we expect the same thing will happen with three-year rates in coming months.

“Banks are anticipating a rise in the cost of funding over the next few years, with the next cash rate hike expected in 2024, if not earlier, and the end of the RBA’s term funding facility in just over one month.

“When the funding wraps up, many banks are likely to recalibrate their rates.”

Opinions diverge

Fixed term interest rates are becoming more popular, but still only account for 35 per cent of all new property loans.

The impact on house prices may yet be minimal. 

ANZ still expects house-price growth of 17 per cent this year and fellow big four lender 

Westpac has revised its property price forecasts, tipping values to rise 15 per cent in 2021. The bank had previously predicted prices would rise 10 per cent in 2021 and again in 2022 but changed its tune last month.

NAB is currently forecasting house price growth of around 10 per cent for Australia’s capitals in 2021, with apartment price growth likely to be a bit more subdued, particularly in Melbourne and Sydney.

Marcus Roberts, founder and mortgage broker of Brighter Finance, said investor activity was likely to continue to grow throughout 2021.

“I’d expect continued interest through the winter period as, anecdotally, when speaking with local agents they’re not expecting a usual colder months shutdown, as stock levels aren’t up to the demand from purchasers,” he said.

Many of the tighter lending conditions and increases in red tape that were applied during the height of COVID concerns are being lifted, he added.

“Some of these temporary policies are now being removed, or at the very least reduced, such as the volume of requirements to prove continuation of income,” Mr Roberts said.

“Certainly, there is still trepidation among the lenders around some applicants’ occupations but generally many of the added requirements are starting to disappear. 

“Due to the high volume of property transactions, many lenders have now ceased providing fully assessed pre-approvals, or are only looking at them if an applicant is going to a specific auction, and hopefully, as the year progresses these lenders will open these applications again, as it provides certainty for clients looking to purchase.”

Associate Professor Shams said a range of other variables might shape the cost of credit, including flexibility in terms of access to credit and from banks, a move to membership-based credit unions, market sentiment about the unemployment rate, and the duration of ongoing pandemic.

Either way, now was regarded as the perfect time to lock in a loan at a low interest rate.

“If investors can lock into these low rates at least for the next few years, that would be good as the interest rate will not likely be this low for too long – there’s very little risk of it going lower,” he said.

Political positioning

In February, Prime Minister Scott Morrison said, “We are not running a blank cheque Budget.” 

In spite of this, he promptly released his second consecutive Budget with a $100 billion deficit, with spending that was likely to propel rather than subdue red hot housing markets.

Eliza Owen, head of research at property data firm CoreLogic, said much of the Budget’s home ownership policies were designed to encourage more buyers while protecting current prices for owners.

“In contrast to the Labor party platform of reducing housing demand through the 2016 and 2018 elections (via reducing or removing incentives for housing investors), the Federal Government has utilised a different approach to boosting the rate of home ownership,” Ms Owen said.

“They focus on increasing accessibility of mortgages, rather than risking any downward pressure on residential property prices.”

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Banks start to move away from record-low fixed rates

Record-low fixed rate loans could be on the outer, with a significant number of Australian banks hiking rates on four-year fixed terms over the past month.

Research by RateCity.com.au showed 14 lenders had increased their four-year fixed rates, following the lead of the  Commonwealth Bank of Australia, which increased its rates for four-year fixed terms last month.

RateCity research director Sally Tindall said the movement by the banks was in anticipation of a likely official cash rate increase in early 2024, if not before.

“So far Australia’s second largest bank, Westpac, has kept its four-year fixed loan at a record low of 1.89 per cent, but it’s hard to see this rate sticking around for long,” Ms Tindall said. 

“The idea of paying under 2 per cent interest until 2025 is an incredibly attractive proposition for many homeowners, but that doesn’t automatically make it a good idea. Take the time to work out what type of loan suits your finances. 

“Fixed loans come with extra restrictions such as caps on extra repayments, typically no offset account and break fees if you want to get out early.” 

Ms Tindall said another option would be to split a home loan so it is part fixed and part variable, which typically allows for extra repayments on the variable portion. 

“A split loan can help you take advantage of the record low fixed rates on offer now, but still allow you to get ahead on your repayments to lessen the blow when rates do rise,” Ms Tindall said. 

“Money might be cheap now but in a few years’ time it’s likely to be a very different story, provided the economic recovery stays on track, particularly for anyone coming off a fixed rate.” 

Earlier this week, ANZ cut its variable package rates, making the first reduction for variable rate loans by a big four bank since September.

Canstar group executive of financial services Steve Mickenbecker said the decrease was being passed on to new borrowers by way of increasing a discount applied to its standard variable rate loan, which would not be passed on to existing borrowers.

“ANZ now offers the lowest package rate among the major banks and it would not be surprising to see others moving down the same path,” Mr Mickenbecker said.

“ANZ is seeking to grow its share of low risk business, with the gap between lending to borrowers with equity below 20 percent and those with greater equity widening from 5 to 20 basis points.”

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