Warning mortgages could see 56 per cent increase if US inflation scenario plays out

In the children’s fairytale Goldilocks and the Three Bears, Goldilocks encounters three bowls of porridge. One that is too cold and one that is too hot, until, of course, she settles on one that is just right.

As the world continues its long and challenging recovery from the coronavirus pandemic, the global economy and Goldilocks, ironically have a great deal in common.

Economies around the world must not be too cold (recessionary and deflationary) or too hot (inflationary), lest major issues begin to swiftly arise.

Going forward, the global economy faces the contractionary forces of struggling economies across the world, relatively anaemic recoveries outside of nations that have engaged in enormous levels of stimulus and declining demographics in most of the world’s largest economies.

At the same time, the ghost of inflation that scarred households in the 1970s and 1980s may have returned to haunt us once more.

But how does all this impact house prices? Let me explain.

Demand outweighs supply

As Western nations, most notably the United States, continue to pump trillions of dollars into their economies, there is simply too much demand for goods and not enough supply.

The spending that normally goes toward things like travel, entertainment and dining out is being redirected toward retail and other goods. Due to this unprecedented increase in demand, wait times for finished goods and raw materials have blown out to all time highs, according to some indexes.

At the same time, supply chain disruptions and increased consumer demand has resulted in the prices paid by manufacturers in the US rising at the fastest rate in over 40 years.

As a result of these higher costs and supply chain issues, some large multinationals have already announced that they will be soon raising their prices.

Most notably Coca Cola and Procter & Gamble (the conglomerate that owns many household brands including Oral-B, Vicks and Pantene) have both committed to raising prices.

According to the latest US inflation figures, these forces may be starting to significantly impact the prices paid by American consumers.

A rise in inflation

In April, US consumer price inflation rose by a whopping 0.8 per cent for the month, marking the largest single month rise in US inflation since 1981.

Wall Street was extremely shocked by the magnitude of the inflationary impulse for April, with the consensus estimates from analysts sitting around 0.2 per cent.

Even before the recent inflation figures rattled global markets, pressure was already building on the US Federal Reserve (The Fed) to consider raising interest rates if inflation became a significant issue.

Earlier this month former US Federal Reserve Chairwoman and current Treasury Secretary Janet Yellen, stated in an interview that the Federal Reserve may need to raise interest rates to counter rising levels of inflation.

In a recent op-ed for Bloomberg, former New York Federal Reserve President William Dudley estimated that the federal funds rate (the US equivalent of the Reserve Bank’s cash rate) could rise as high as 4.5 per cent as The Fed attempted to cope with a more inflationary future.

Between the growing likelihood that the global economy may be scarred in the long term by the pandemic and rising concerns about inflation, the ‘Just Right’ zone for the world economy is arguably narrowing.

How would these scenarios impact Australia and New Zealand?

High inflation:

If Dudley’s worst case high inflation scenario was to be realised (a 4.5 per cent bump in the cash rate), mortgage holders would face a significant increase in their repayments.

Based on the average new mortgage size for an Australian owner occupier of A$478,822 and the RBA average rate payable on new loans, mortgage repayments would rise from A$2217 per month today to A$3471 per month.

In New Zealand, the average borrowing for first home buyers with a deposit of less than 20 per cent in 2019 was $441,640.

The Kiwi first home buyer paying a two-year mortgage rate of 2.55 per cent would see payments increase from $1992 per month to $3107 per month.

This would amount to an increase in monthly repayments of over 56 per cent and would almost certainly result in a large number of households falling into mortgage stress. Mortgage stress is generally defined as a household spending more than 30 per cent of their pre-tax income on paying their mortgage.


In a deflationary scenario where trillions in stimulus fails to adequately underpin the global economic recovery, the Aussie economy would likely head back into recession.

Unemployment would also rapidly begin to rise without yet another round of large scale intervention by the federal government.

However, this scenario holds a number of uncertainties. Unlike a high inflation future which is much harder for central bankers and political leaders to address, it’s entirely possible, perhaps even likely that the government could simply throw another couple of hundred billion dollars at the economy.

Into an uncertain future

As economists and commentators have shown in recent months, predicting where the global and Australian economies may head from here is more challenging than ever.

Around the world even some of the world’s most prominent investors and former senior central bankers are raising the alarm about the possibility of runaway inflation, in a world where interest rate hikes to counter these forces could be devastating to asset prices.

Meanwhile, multiple data releases in the United States and elsewhere have pointed to the downside in a big way, raising concerns that the stimulus driven recovery may already being showing signs of slowing.

It’s entirely possible that the world may once again muddle through the coming years as it has before. But as the distortionary effects of over US$24 trillion in global stimulus feed into the world economy and ultimately fade away in time, risks continue to build that the Goldilocks global economy may find that things end up being too hot or too cold.

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