RBA to gradually increase rates to avoid mortgage shock top economists predict

An increase in household debt during the COVID-19 recession will force the Reserve Bank to only gradually increase borrowing costs, the nation's leading economists believe, although they warn official interest rates could easily climb above 3 per cent.

Ahead of the RBA's March meeting on Tuesday, most economists in The Sydney Morning Herald/The Age Scope survey expect rates to remain on hold until August, with some saying home buyers could have respite until 2023.

The Reserve Bank of Australia is tipped to start raising rates after August.Credit: Louie Douvis

The RBA has kept the official cash rate at a record low 0.1 per cent since November 2020, adding to its quantitative easing program that has pumped more than $400 billion into the economy through the recession.

The bank used its February meeting to end quantitative easing, and financial markets now expect it to lift the cash rate by more than a percentage point this year to deal with growing inflation pressures. The consumer price index rose 3.5 per cent through 2021 and is likely to lift higher through the first six months of this year.

But Scope members are not as hawkish about the bank's interest-rate plans as financial markets, with most highlighting the level of housing debt taken on by Australians as a key factor.

St George chief economist Besa Deda, who believes the cash rate will peak at 1.75 per cent in 2024, said the sharp lift in debt meant interest-rate movements were more potent.

"As the overall level of household debt is relatively high compared to history and the cash rate is at record lows, future interest-rate increases will have a larger impact on households than in previous cycles," she said.

AMP Capital chief economist Shane Oliver, who believes the cash rate will peak between 1.5 and 2 per cent in the next 18 months to two years, said higher rates would slow economic growth, the jobs market and housing to keep inflation under control.

"Higher housing debt-to-income ratios than in the past has made the housing market more sensitive to rising interest rates," he said.

"And a significant number of fixed mortgage rate loans expiring in 2023 and rolling over into much higher mortgage rates will act as a de facto monetary tightening. All of which will constrain the amount by which the cash rate will need to increase."

Newcastle University professor of economics Bill Mitchell said the RBA was likely to be cautious with interest-rate movements given the scale and precariousness of household debt.

Rate rises would probably fail to dampen inflation pressures and could add to them by pushing up business costs.

"Given the inflationary pressures at present are not being driven by a demand explosion, there will be little impact from rising rates, which will not stop the cartel gouging from OPEC, nor make ships and trucks go faster, nor cure COVID and get workers back to work more quickly," he said.

But some Scope members warn interest rates will push back closer to long-term averages of at least 3 per cent.

Former RBA economist and now chief economist at the Centre for Independent Studies, Peter Tulip, believes the cash rate could peak at 5 per cent.

Leading independent economist Steve Koukoulas believes the cash rate could reach 3.5 per cent late next year or early 2024, coinciding with unemployment settling between 3.5 and 4 per cent.

University of Western Australia macroeconomist Jakob Madsen is the most hawkish of the Scope panel, saying over the next five years the official cash rate could hit 8 per cent. The last time it was at that level was in the early 1990s as the RBA was slashing rates in response to that period's recession.

"A thing people and economists forget is that the interest rate has never been lower than now," he said.

"The low interest rates have so far been driven by the savings glut in Asia. However, the party is over. People in the whole world are getting older - particularly the east Asians that, thus far, have been the big savers. They will now use their savings during their retirement, which in turn will force interest rates up."

EY chief economist Jo Master said while interest rates had bottomed out, an increase was not a bad sign.

"It's important to remember that rising interest rates are a sign of a strong economy and that the first round of interest-rate hikes will make monetary policy less stimulatory - we are a long way from contractionary settings," she said.

"We do not expect higher interest rates to stop the economic recovery, but make it more sustainable by avoiding overheating."

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Shane Wright - Shane is a senior economics correspondent for The Age and The Sydney Morning Herald.Connect via Twitter or email.Jennifer Duke is an economics correspondent for The Sydney Morning Herald and The Age, based at Parliament House in Canberra.Connect via Twitter or email.