Borrowers need to brace themselves for the risk of a sharp rise in interest rates, with recent sharemarket turmoil a “warning sign” of volatility to come.
The Reserve Bank has again signalled that it expects the official cash rate (OCR) to stay at the current record low of 1.75% for more than another year as inflation stays low.
In recent days sharemarkets across the globe have seen wild movements, as investors worry that the US economy is finally showing signs of inflation, after news of stronger than expected wage growth.
This could mean the recent boom fuelled by cheap borrowing may come to an end sooner than people believed.
“You have to say, well, it’s a bit of a warning sign, because that volatility, it shows how nervous the market is about the prospects for interest rates and normalisation of interest rates and inflation,” Spencer said.
“Currently the market’s expecting that to be gradual. If it was more sharper then you could have more volatility down the track.”
A stronger than expected global recovery and resurgent inflation could mean “the interest rate reaction could be quite sudden”. As well as hitting demand for exports, Spencer said heavily indebted home owners could also feel pain.
“Mortgage rates, particularly on fixed [rate] mortgages, even if we kept the short rates constant, the OCR constant, those term rates would increase.
“For new borrowers, or people rolling over mortgages, the cost of servicing the mortgage is going to increase when that happens. This is why borrowers, and banks, have to be careful about making sure that debt service capacity is there, not just at today’s rates, but at rates that are a bit higher.
Spencer said borrowers should be preparing, to ensure they could cope with a scenario of sharply higher borrowing costs.
The Reserve Bank’s head of economics Dr John McDermott said later that the bank could react to a sharp upswing in interest rates by slashing the OCR, however there was always the risk that its response was not sufficiently timely.
Stay tuned for the latest property news summaries and information, sent to your inbox fortnightly Sign up now