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US Interest Rise May Hit Australian Home Loan Rates

The era of easy money is drawing to a close as financial markets prepare for the US Federal Reserve to increase official interest rates for the first time since 2004. That may be bad news for Australian borrowers as local banks look to protect their margins from the flow-on effects of any such rise.

The US economy is growing again – official figures show an annualised pace of 2.3% in the three months to June – and analysts now expect the Fed to raise interest rates in September.

Indicating the US may be moving into an economic upswing, consumer spending jumped to 2.9% in the quarter from 1.8% in the first three months of the year, and more than 200,000 jobs were created each month, paring the unemployment rate to 5.3%.

The case for a US rate rise: US inflation expectations and wages growth, 2011-15

 

image 1

Sources: BlackRock Investment Institute, Thomson Reuters and US Bureau of Labor Statistics, June 2015. Notes: Inflation expectations reflect the average expected inflation rate over the next five years, starting five years ahead. Wages growth is based on the 12 month change in the US Employment Cost Index.

More cash, more bubbles

However, there are reasons to be cautious.

BlackRock global chief investment strategist Ewen Watt says every investment class has been affected by central bank policies over the past eight years. An extra US$8 trillion in cash has been printed by the European Central Bank, Bank of England, Bank of Japan and the US Fed, which has inflated asset prices, driven bond yields down and spurred equity prices.

He adds, though, that equity prices have been pushed up by valuations rather than earnings growth, which is clearly illustrated in the graph below.

Global equities and earnings, 2002–2015

 

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Source: BlackRock

 

“This trend tends to happen in a bull market but will likely end once monetary policy tightens. Earnings growth has to take over to avoid a bubble,” Watt says. On the plus side, he notes that earnings growth is now coming through in most regions.

Why US rates may affect Australian borrowers

The reason Australian mortgage holders may suffer is not as simple as assuming domestic interest rates will follow US rates. That’s unlikely, at least in the short term, as the Reserve Bank of Australia (RBA) actually may be forced to cut again if the Australian economy slips.

Higher US interest rates will put downward pressure on the Australian dollar, which will be welcomed by companies that benefit from the lower currency, but those with stretched valuations are at risk, according to the co-founder of Sydney-based fund manager Eley Griffiths Group, Ben Griffiths.

Financial stocks – banks more than insurers – and real estate institute trusts traditionally have been the most sensitive to rate movements and will struggle to meet market expectations, he says.

Analysts at investment bank Morgan Stanley warn that the big four Australian banks may start raising interest rates on all home loans, not just the investment loans that all banks have started lifting.

They say the higher rates on investment loans will not be enough to protect the banks’ profit margins, so shareholders will win out over customers and home loan rates will inch up regardless of what the RBA does with official interest rates.

In many cases, the amount of money the banks lend to owner-occupiers is double that lent to investors.

RBA official interest rates

 

Source: RBA

Source: RBA

 

The RBA has cut official interest rates to 2% but BlackRock’s locally-based investment strategist, Steve Miller, says there are “a few more rate cuts in the RBA locker” and the central bank could cut rates in December or early 2016 should the economy deteriorate.

On the plus side, companies in sectors such as tourism will benefit from a lower Australian dollar as overseas visitors will be attracted by the lower cost of visiting and Australians may stay home for their holidays as international travel becomes more expensive.

Commodity exporters will also benefit from the fall as their output becomes cheaper on the international markets. Even so, the demand is unlikely to be strong enough to pull the domestic economy up, BlackRock says.

A downside of a weaker dollar is that the cost of imported goods will rise again.

So now may be the time to think about how to get the best result for your loan, plan a holiday at home and buy local.

 

 

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