Interest rate rise that could spark recession as Philip Lowe defended by AMP Capital economist

Financial markets expect Australian interest rates to rise a further three times by winter, potentially triggering a recession.

The Australian Stock Exchange 30-day interbank futures market predicts the Reserve Bank will raise the cash rate to 4.1 percent for July.

The NAB on Tuesday adjusted its forecasts for the RBA to raise rates to that level in May, after previously expecting a cash rate peak of 3.6 percent.

AMP Capital chief economist Shane Oliver said this would be enough to trigger a recession, which would be the first since 1991 caused by rate hikes.

“I think a cash rate above four per cent would probably drive the economy into recession or very close to it,” he told Daily Mail Australia.

Just a small increase in variable mortgage rates would be as economically destructive as 17.5 percent interest rates were in 1990 because homes, compared to income, now cost two to three times as much depending on the city.

While inflation last year rose 7.8 percent, the biggest annual jump in 32 years, Dr Oliver argued that it was a lagging indicator and he feared the Reserve Bank could make the same mistake it did in 1989. and 1990.

“It could easily happen again and that’s the risk here and that’s why they have to be very careful: we should be nearing the top,” he said.

“The Fed realized in 1990, ‘Wow, we’ve gone too far, the lagging impact of all those rate hikes is really kicking in,’ and then they had to start pedaling as fast as they could, but it was too late. ‘

Dr Oliver said that while he disagreed with Dr Lowe, replacing him once his seven-year term ended on September 17 would be a bad idea.

“It would be a big mistake to replace the governor right now because there are a lot of economic problems, particularly inflation coming down again,” he said.

“Changing the governor will only increase uncertainty.”

Dr. Oliver argued that Dr. Lowe did not deserve to be replaced after wrongly suggesting that in 2021 the rates would stay at 0.1 percent until 2024.

“I know there’s a lot of upset about the 2024 comment and the extent to which interest rates have gone up, but if you go to other countries, interest rates have gone up even more,” he said.

The Reserve Bank has, since May 2022, raised interest rates nine times, with the February increase taking them to a 10-year high of 3.35 percent.

On Tuesday afternoon a week ago, the futures market expected a cash rate of 3.85 percent for June.

That was after Dr. Lowe noted that more rate hikes were on the way in 2023 to address the worst inflation in 32 years.

The market reacted on Friday after The Australian Financial Review revealed that Dr Lowe suggested to bankers at a Barrenyjoey Capital briefing that the cash rate was likely to move closer to the US level of 4.5 % to 4.75%.

“It looks as if the market has taken that event and your comments as confirmation that the RBA has now become more aggressive and is thinking of several more hikes to come,” Dr. Oliver said.

This prompted the futures market on Friday to predict a 4.1 percent cash rate in Australia for July, which would be the highest since December 2011.

The market was still expecting a cash rate of 4.1 percent on Monday afternoon.

With inflation well above the RBA’s 2% to 3% target, Dr Oliver said the Reserve Bank chief wanted to sound tough to possibly encourage Australians to cut spending so they don’t have to raise the rate. of cash beyond 3.6%.

“He wants to sound harsh after the inflation burst in January, but he hopes he won’t have to raise rates as much,” he said.

If this causes the economy to contract for two consecutive quarters, this would be the first recession caused by higher interest rates since 1991.

Dr. Lowe would be the first RBA chief to hold this position since Bernie Fraser presided over interest rates of 17.5 percent in January 1990, when a cash rate target was first published.

Before that, RBA rates had hit 18.6 percent in November 1989.

Back then, houses were much cheaper compared to income, and Dr. Oliver argued that variable mortgage rates of 6 percent would be equivalent to a cash rate of 17.5 percent in 1990.

“There is no need to raise interest rates as much as back then because the debt-to-income ratio is three times higher than it was then,” he said.

Sydney’s median home price of $1.2 million is now so expensive that an average full-time worker on $92,000 would have a debt-to-income ratio of 10.5 after a 20 percent deposit.

That is well beyond the Australian Prudential Regulation Authority’s ‘six’ threshold for mortgage stress.

In 1990, the median Sydney home price of $194,000 was 5.3 times the median full-time salary of $29,344 after a 20 percent deposit.

Dr. Lowe would also be the first RBA chief to preside over two recessions since Bob Johnston was in charge during a long economic downturn in 1982 and 1983, during an era of overnight interbank cash rates of 19 and 21 percent.

Dr. Lowe took office in September 2016 and was governor in early 2020 when summer wildfires and national Covid lockdowns caused a recession.

But without higher interest rates, Dr Oliver argued Australia faced a spiral of wages and prices and a repeat of the 1970s when there was high inflation and high unemployment, a situation known as stagflation.

“We’ll end up with a repeat of the 1970s if we don’t get it under control again,” he said.

“Australians will be even angrier if we don’t.”