Reserve Bank criticised over interest rate guidance

Borrowers likely to feel misled, says economist

Reserve Bank criticised over interest rate guidance

An economist has called out the Reserve Bank over comments made in 2021 that the cash rate would likely remain at 10 basis points until 2024, saying its credibility has been tarnished.

The cash rate, currently 1.85%, has already increased by 175 basis points this year as the RBA moves to rein in inflation and unwind stimulus put in place at the start of the COVID-19 pandemic. 

Former principal adviser to Treasury and ex-ANZ Bank chief economist Warren Hogan (pictured above), who is currently economic advisor to Judo Bank, was recently quoted by Sydney’s The Daily Telegraph as saying the RBA’s forward guidance had the effect of “misleading people”, as borrowers were encouraged to buy homes and take out loans in the belief rates wouldn’t rise for three years.  

In an interview broadcast on ABC’s 7.30 show on June 14, 2022, RBA governor Philip Lowe was interviewed by Leigh Sales.  Quoting a comment made by the RBA following its October board meeting that rates would not rise before 2024, Lowe was asked what had changed from last October.

In response, Lowe told Sales that what the RBA had said right through the last two years was that “if the economy evolved as expected, interest rates were unlikely to increase until 2024”.

For most of the past two years, he said the RBA thought growth would be slow to recover, inflation would stay fairly low, and that there’d be a long tail from the pandemic. Given that, the RBA thought interest rates would need to remain where they were until 2024, he said.

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Speaking to MPA about the comments made by the RBA in 2021 in relation to the official cash rate, Hogan said the RBA’s explicit forward guidance was that it would keep the cash rate at 0.10% until 2024.  The RBA followed that line all the way until around October 2021, he said.

Hogan questioned why the RBA gave this forward guidance, saying it had no greater ability to forecast what would happen in the future than other commentators. The institution as a whole was too valuable for the RBA to be making its own prognosis over future events, he said.

In an environment where house prices were rising, he said the RBA incorrectly assumed mortgage brokers, real estate agents and other industry professionals would understand the conditional factors around keeping interest rates at record lows.

“It’s naïve to think that people wouldn’t take them at face value,” Hogan said.

Hogan said the RBA underestimated the effectiveness of the COVID-19 health response and put too much at risk in the hope of getting “more bang for their buck”.  In hindsight, the economy surged out of lockdown and inflation rose at the fastest rate in around 40 years, he said.

From a borrower perspective, Hogan was concerned about a cohort of mainly first home buyers, and possibly also some investors and some owner-occupiers, who were highly leveraged and would “feel misled” that interest rates were going up sooner than they expected. 

Hogan also noted that a high portion of mortgage borrowers were on variable home loan rates and would therefore take an immediate hit from these cash rate rises.

First home buyer activity surged during the pandemic, and people who borrowed one-to-two years before interest rates started to rise were the most vulnerable, he said.

“It’s the first home buyers that tend to be the most exposed in any new tightening cycle (cycle of higher rates) because they take the most risk in any market: they’re typically young, they’ve got potential for promotion and higher income, and they’ve got time,” Hogan said.

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While Hogan said he agreed with comments previously made by the RBA that overall, households remained in a strong position to manage interest rate rises, he expected there would be “pockets of significant distress”.

“The critical cohort (people with less financial flexibility) represents less than a third of the market, but they’re going to be under pressure,” Hogan said.

“At the moment, the saving grace is that we’ve got jobs and demand for labour is still very good”.

Talking to Leigh Sales on ABC’s 7.30 show on June 14, Lowe said the economy didn’t evolve as the RBA expected.

“It’s been much more resilient, and inflation has been higher. And we needed to respond to that,” Lowe said.

Lowe told Sales he understood people would make borrowing decisions based on RBA communications, and that people took out loans they may not have otherwise taken out.

“I also point to the fact that the economy’s done remarkably well. The unemployment rate is at a 50-year low, a higher share of the population has a job than ever before, households have built up very large financial buffers,” Lowe said.

Lowe said households had put away an extra $250 billion, and the savings rate remained high. The number of people who had fallen behind in their mortgages was declining, not rising, he said.

“So there’s a lot of resilience in the household sector. At the individual level, some people have taken out loans that they may not have wanted to take in retrospect, but the overall picture, which is really very much the focus of the Reserve Bank, is of a pretty resilient economy.”

Lowe said in June it was unclear how far interest rates would need to rise to get inflation back towards the RBA’s target range.  In the RBA August monetary policy statement, he said the bank’s central forecast was for inflation to peak around 7.75% over 2022.

In response to whether he agreed with the four rate hikes delivered by the RBA this year, Hogan said they were “utterly appropriate”, noting that a neutral interest rate (a rate that doesn’t help or hinder the economy) was at least 2.5% to 3%.

However there was now a bigger question around the need for the RBA to keep hiking the cash rate at the same pace, particularly given vulnerabilities of certain borrowers and how parts of the economy would react, he said. 

He said the RBA would also need to be wary of raising interest rates in an inflationary environment where wages were only gradually adjusting.

“Their [the RBA’s] economic forecasts are assuming a cash rate of 3% by the end of the year… I’m comfortable with the view that the cash rate goes up further, but the pace they’ve been setting of 50 basis points every month very shortly, will need to go back to 25 basis points,” Hogan said.

If the cash rate nears 3%, Hogan said the dollar value of mortgage repayments in the December quarter would be almost double what they were the December 2021 quarter.