At its July board meeting, the Reserve Bank of Australia (RBA) lifted the cash rate target by 50 basis points, in line with market expectations, bringing the official cash rate target to 1.35%. It also increased the interest rate on Exchange Settlement balances by 50 basis points to 1.25%.
This marks the third month in a row that the RBA has raised rates, with further increases expected over the course of this year as the central bank seeks to contain rising inflation. The third back-to-back rise follows an increase of 50 basis points in June – the largest increase since February 2002 – and 25 basis points in May. May’s increase was the first since 2010, as the central bank lifted the cash rate from its record low emergency level of 0.1%.
Global inflation is soaring. It is being boosted by COVID-19-related disruptions to supply chains, the war in Ukraine, and strong demand which is putting pressure on the capacity of production. Although monetary policy globally is responding to this higher inflation, it will be some time yet before inflation returns to target in most countries.
As part of the response, rate hikes are happening across the globe. The aim is to slow down economies and bring supply (production) and demand (spending) back into balance to address the soaring inflation rates. Nearly all central banks across the globe are lifting rates from ‘emergency’ levels to reflect more ‘usual’ functioning economies because of this.
In a statement from the RBA, Governor Philip Lowe had this to say on inflation in Australia:
“Inflation in Australia is also high, but not as high as it is in many other countries. Global factors account for much of the increase in inflation in Australia, but domestic factors are also playing a role. Strong demand, a tight labour market and capacity constraints in some sectors are contributing to the upward pressure on prices. The floods are also affecting some prices.
Inflation is forecast to peak later this year and then decline back towards the 2–3% range next year. As global supply-side problems continue to ease and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Higher interest rates will also help establish a more sustainable balance between the demand for and the supply of goods and services. Medium-term inflation expectations remain well anchored and it is important that this remains the case. A full set of updated forecasts will be published next month following the release of the June quarter CPI.”
An important factor to note in all of this is COVID-19. Workers are continuing to contract the virus and are forced to stay at home, resulting in fewer goods and services being produced. But economies are continuing to recover from the virus, with spending lifting. Unfortunately, spending is recovering more quickly than production. The other key factor is the war in Ukraine, driving up energy and food prices across the globe.
In the statement from the RBA, Mr. Lowe commented on the Australian economy:
”The Australian economy remains resilient and the labour market is tighter than it has been for some time. The unemployment rate was steady at 3.9 % in May, the lowest rate in almost 50 years. Underemployment has also fallen significantly. Job vacancies and job ads are both at very high levels and a further decline in unemployment and underemployment is expected over the months ahead. The Bank’s business liaison program and business surveys continue to point to a lift in wages growth from the low rates of recent years as firms compete for staff in the tight labour market.
One source of ongoing uncertainty about the economic outlook is the behaviour of household spending. The recent spending data have been positive, although household budgets are under pressure from higher prices and higher interest rates. Housing prices have also declined in some markets over recent months after the large increases of recent years. The household saving rate remains higher than it was before the pandemic and many households have built up large financial buffers and are benefiting from stronger income growth. The Board will be paying close attention to these various influences on household spending as it assesses the appropriate setting of monetary policy.
The Board will also be paying close attention to the global outlook, which remains clouded by the war in Ukraine and its effect on the prices for energy and agricultural commodities. Real household incomes are under pressure in many economies and financial conditions are tightening, as central banks increase interest rates. There are also ongoing uncertainties related to COVID, especially in China.”
Central banks are ‘front loading’ rate hikes to try and get on top of inflationary pressures. That is, rates are being lifted more quickly and more aggressively than usual. The fear is that if higher rates of inflation take hold – become cemented in people’s consciousness – then it will take longer to bring the inflation rates back to preferred levels.
The risk with these ‘harder and faster’ rate increases is that they could cause economies to go into recession. Recessions are defined differently across the globe, but in Australia, the general definition of a recession is two consecutive quarters of economic contraction (declines in gross domestic product).
For a typical owner-occupier with a $500,000 mortgage and 25 years remaining, this increase will see their monthly repayments rise by $137, according to RateCity.
Their total increase to date from the May, June, and July rate hikes would be $333 per month.
For a borrower with a $1 million mortgage, today’s decision will add $273 to their monthly repayments, bringing their total increase to $665 per month since April.
CoreLogic figures also showed national house prices fell for the second consecutive month in June by 0.6 %.
From the statement from the RBA:
“Today’s increase in interest rates is a further step in the withdrawal of the extraordinary monetary support that was put in place to help insure the Australian economy against the worst possible effects of the pandemic. The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed. The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”
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