As central banks around the world rapidly raise interest rates, policymakers outside the United States may find that it has more leverage in terms of demand reduction.
- The reason comes down to the unique way Americans finance their homes.
Why is this important: Americans tend to take out mortgages with fixed interest rates for long periods, up to 30 years. This means that when the Fed tightens, more owners are not concerned.
- This is not the case in other countries across much of Europe, Australia and Canada, where soaring mortgage rates can lead to higher monthly payments.
From the central bank From this perspective, rate hikes can dampen demand in a very direct way.
- For example, the Reserve Bank of Australia performed a sensitivity analysis showing that a 2.5 percentage point rise in rates caused an Australian family, with typical income and mortgage debt levels, to see their flows monthly free cash flow down 13%.
Yes, but: This may be good for lowering inflation, but it means economic pain for homeowners. The OECD recently warned that “low-income families in countries with high household debt and where variable-rate mortgages are widely used, such as some Nordic countries, could be particularly vulnerable” as rates rise. .
Between the lines: In countries where mortgage lending is predominantly of variable type, “the necessary tightening and demand reduction is widespread,” says Krishna Guha, vice president of Evercore ISI. “Rates may not have to increase as much because the increase is largely income-based.”
How it works: When as mortgage rates reset, homeowners tend to change their spending habits in response, according to a document released by the Dallas Fed earlier this year.
- It focused on the Canadian housing market — where the vast majority of mortgages are considered “fixed rate”, which resets every two to five years. The findings have implications for other countries, where short-term fixed mortgages are common.
- When a reset resulted in a higher rate and higher monthly payments, consumers didn’t seem to cut back on expensive durable goods. But there are signs they’ve cut elsewhere, including a corresponding drop in credit card balances.
- From an accounting point of view, [it] means they must have reduced other expenses or savings,” Katya Kartashova and Xiaoqing Zhou, the paper’s co-authors, said in an email.
Where is it : At the end of last month, about half of all variable rate mortgage holders in Canada – those with fixed payments, about 13% of all mortgages – were reset to the level that would result in higher payments , the country’s central bank said. the week.
- “These borrowers may need to adjust their spending or use their savings to meet their higher debts,” the researchers write.
- Those who bought last year, when variable rates were at an ultra-low 1.5%, face the worst shock as rates approached 5% last month. These monthly payments would have increased by about 20%.
The big picture: On the one hand, officials in these countries could see the effect of monetary tightening trickle down to the economy sooner, as existing borrowers curb their spending (thereby slowing demand) due to increased remittances. mortgages.
- On the other hand, this means that the burden of the policy falls overwhelmingly on the owners. The result could be a political backlash: Philip Lowe, Australia’s top central banker, today issued an unusual apology to regrettable mortgage holders who relied on the central bank’s early indications that rates would not increase until 2024.
- Economists have begun to warn against “mortgage dominance”, the idea that central bankers are abandoning aggressive interest rate hikes for fear of the impact on homeowners. As the Financial Times points out, Norway’s central bank has scaled back rate hikes after a bigger-than-expected shock to its housing market.
What to watch: The problem is perhaps most acute in the UK, where rates have recently soared amid wider market fallout from the failed tax cuts proposed earlier this fall.
- “Much of the tightening that the central bank is executing will result in a massive shock to the incomes of about 4 million households, in addition to the cost of living crisis,” Guha said. She estimates that the total number of two-year variable-rate and fixed-rate mortgage holders is 4 million.
- “It’s a huge distribution problem that the central bank can’t solve because they don’t have the tools to do it.”
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