The RBA announced that it would be increasing interest rates in May 2022 in order to combat the rising inflation levels caused by the coronavirus pandemic.
This is a reversal of the interest rate policy that was in place for more than ten years, during which time interest rates fell consistently. The RBA has been raising interest rates each month since May, with increases of 0.5% in June, July, August and September. However, the RBA surprised observers by only raising interest rates by 0.25% in October and November.
The current interest rate tightening cycle has been introduced by the RBA to counter sharply rising inflation. With the latest ABS September quarter headline annual growth rate of 7.3%, it is clear that something needs to be done to quell demand and create a more balanced relationship with supply.
While higher interest rates can achieve this goal, there is also the risk that sharply reduced demand will create a severe economic downturn.
The low interest rates currently offered in Australia are reflective of the RBA’s watchful approach to monetary policy. Whilst they are mindful of the lagged impact of interest rates on the economy, they are also keen to maintain a strong local economy.
This is in contrast to other economies, whose inflation issues stem from a mismatch between demand and supply. In Australia, higher services costs still account for a relatively small proportion of overall inflation. This is largely due to subdued wage growth, which is a result of Australia’s unique wage setting policies.
Previously, the heights of RBA interest rate tightening cycles were 7.5% (July 1996), 6.25% (December 2000), 7.25% (August 2008) and 4.75% (October 2011). Interest rates are predicted to increase to around 3.75% in 2023, which would be well below the other peak results.
Economists from Australia’s big four banks currently have different opinions on when the cash rate will rise and what the peak will be. ANZ economist David Plank predicts that the cash rate will rise to a high of 3.85% by May 2023, CommBank economist Gareth Aird predicts that the cash rate will rise to a peak or “terminal rate” of 3.10% by December 2022, NAB economist Alan Oster predicts that the cash rate will rise to a high of 3.60% by March 2023, and Westpac chief economist Bill Evans predicts that the cash rate will be lifted to the level of 3.85% by 2023 with a possible rate cut by 2024.
(Note that the above figures were provided at the time of publication)
The RBA has also recently stated that it is prepared to keep rates unchanged for a period while it assesses the state of the economy and the inflation outlook. This may mean that official interest rates are placed on hold sooner than expected.
Dr Andrew Wilson – Chief Economist, My Housing Market
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