What higher rates mean for inflation, the economy and loans? Straits Times 2022-06-18

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ST Explains: How will rising rates in the US affect housing loans and property prices in Singapore?

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ST Explains: What higher rates mean for inflation, the economy and loans?

Chor Khieng Yuit

Senior Correspondent

2022-06-18

SINGAPORE - Investors and consumers have had to grapple with the three Rs - rising prices, rising interest rates and the dreaded recession - for the past few weeks.

The United States central bank has hiked rates three times in the past four months to tame inflation, leaving benchmark rates between 1.5 per cent and 1.75 per cent.

ST Explains asks whether raising rates will work this time round.

1. Will the Fed be able to dampen inflation in the US by raising interest rates?

Mr Sani Hamid, director of economics and market strategy at financial advisory firm Financial Alliance, said raising rates will help to cool down inflation that is demand-driven. So if rising prices are due to excessive consumption and demand, higher rates will make it more expensive for households and companies to borrow money and in turn, help to reduce demand and tame inflation.

The issue now, Mr Sani said, is that the inflation that the world is experiencing is largely due to supply challenges, including high agricultural prices and supply chain disruptions as a result of the Russia-Ukraine war and Covid-19 lockdowns in China.

He noted that these challenges are outside the control of central banks. In other words, higher rates will do little to ease the supply crunch that is driving up prices.

Mr Sani thinks the US is already in a stagflationary environment of high inflation and slowing growth.

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"We are on that path. If you look at what the Federal Reserve has mentioned, the rates are going up, inflation is high and yet they have actually marked down their growth forecasts," he added.

So has the Fed run out of policy options? Will it still be able to manoeuvre a soft landing for the US economy?

There has been talk in various quarters of a recession next year.

Singapore Prime Minister Lee Hsien Loong warned last month that the world could tip into a recession within the next two years.

2. What will be the spillover effect on Singapore? Is it also facing a recession?

Dr Chua Hak Bin, senior economist at Maybank Kim Eng Research, said growth in Singapore has not stagnated yet. But, he warned that if the Fed is overzealous in its rate hikes, it could tip both the US and Singapore economy into recession.

"We don't think it will happen this year. But, it could happen next year," he noted.

Dr Chua added that Singapore corporates and households should brace themselves for a big interest rate shock as short-term rates will move sharply higher.

He expects mortgage rates to climb to about 4 per cent by year-end and possibly 4.5 per cent in 2023, levels that have not been seen for almost two decades.

"That is going to take a bite out of consumer wallets. And from the companies' side, those who are heavily leveraged, that will also cut a proportion of their cash flows," Dr Chua added.

Mr Christopher Tan, chief executive of wealth management and advisory firm Providend, said those who have been spending beyond their means will be particularly hard hit: "People may lose their jobs and when all these loans start going up, a lot of people will get into trouble within the next one to two years."

3. Besides mortgages, what other consumer loans will possibly be affected by higher rates in the US?

Higher US rates will affect the Singapore Overnight Rate Average (Sora), the new interest rate benchmark that has replaced the Singapore Interbank Offered Rates (Sibor).

Sora is used to price all loans and financial products.

So new car owners will have to brace themselves for higher interest rates, said Mr Alfred Chia, chief executive of SingCapital.

Mr Chia said once the banks increase their fixed-deposit rates, their cost of funds will go up and they will have to pass these on to car owners.

However, existing car owners with loans will not be affected.

Mr Chia said car loans have a fixed interest rate, with a maximum loan term of five years.

He noted that the biggest debt burden for Singaporeans is credit card debt but he does not think interest rates for this will go higher as they are already very high at 25 to 26 per cent.

Providend's Mr Tan warned of another potential debt bomb - single premium insurance policies such as universal life insurance policies.

MoneySense, Singapore's national financial education programme, notes that such policies charge a large upfront lump-sum premium that can run into seven figures.

Taking up a loan to pay for the premiums - known as premium financing - may sound attractive when interest rates are low, Providend's Mr Tan said.

He noted that banks have also been selling premium finance endowment plans, premium finance annuities and premium finance retirement plans.

"The last few years when interest rates were low, people will basically borrow to buy all these insurance policies, said Mr Tan, who added that as rates go up, the monthly payment can become very expensive.

"What that means is that if your interest rate goes up, every month when you get retirement income, you have to net off the interest. So your retirement income also dropped already, he said.

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