Households’ record debt raises fears that rising interest rates could lead to a recession

“You might get 100 points over a couple of years, but that would require the economy to grow much faster, inflation to be much higher, and wage growth much higher than it is now.”

Dr. Oliver said given the level of household debt, even a small rise in interest rates would mean they would have much less to spend, which in turn would lead to slower economic growth and employment.

The Australian Bureau of Statistics’ lending data shows that the average new mortgage in NSW has now reached a record high of $ 685,000, an increase of $ 120,000 over the last 12 months. In Victoria, the average has risen by $ 116,000 to a record $ 558,000.

The financial markets have priced the official cash rate to rise by a full percentage point by the end of next year.

That kind of increase would increase the monthly repayment on a $ 685,000 mortgage by $ 364 or almost $ 4400 a year. On a $ 558,000 mortgage, the repayment would increase by $ 297 per month.

A cash rate of 1.15 percent would be far from the 4.25 percent that the RBA had in the wake of the global financial crisis. An increase to this level would raise the monthly repayment on a mortgage of $ 685,000 to $ 4,307, while that of $ 558,000 would jump by $ 1362 per month.

The value of mortgages in Australian banks has increased through COVID and has increased by $ 132 billion to $ 1.2 trillion. They also have an additional $ 650 billion in investor loans.

AMP Capital's chief economist Shane Oliver says a full percentage point rise in interest rates by December next year will drive the economy into recession.

AMP Capital’s chief economist Shane Oliver says a full percentage point rise in interest rates by December next year will drive the economy into recession.Credit:Louie Douvis

Senior Australian Capital Economics economist Marcel Thieliant said that even a 0.75 percentage point increase in interest rates would increase the share of a homebuyer’s income to pay off their mortgages to 10-year highs.

“In that scenario, house prices would have to fall by 12 percent in order for affordability to return to its long-term average,” he said.

“But if the RBA raised interest rates by a major 200 basis points instead, housing would become the most unaffordable since the global financial crisis, and a much larger 21 percent correction in prices would be required to bring affordability back to its long-term average.”

EY chief economist Jo Masters said interest rates had most likely taken a structural step down due to the pandemic.

She said this would cause challenges for both the Reserve Bank and the federal government.

“This means that monetary policy will more often be limited by the lower zero limit in the future, and therefore have to use unconventional policy tools more often,” she said.

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“Implicitly, fiscal policy will have to play a greater role in managing the economic cycle.”

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