With contribution from Shane Oliver from AMP Capital.
The RBA raised its cash rate by another 0.25% taking it to 3.35%. This is the ninth consecutive rate hike in a row over ten months totalling 325 basis points and exceeds the 2002-2008 tightening cycle (of 300 basis points over 71 months) making it the biggest tightening cycle since the 1980s. Prior to 1990 the RBA cash rate was not officially announced, and short-term rates were very volatile. In the period January 1988 to November 1989 the overnight cash rate rose from 10.6% to 18.2% but mortgage rates were more regulated then and “only” rose from 13.5% to 17%.
Are we there yet?
While the RBA stepped up its hawkishness and another rate hike now looks likely next month, its commentary is not necessarily a great guide to what happens with rates – just a bit more than a year ago it didn’t expect rates to start rising until 2024 at the earliest! What happens to inflation and growth will be key. Given the experience of the last year one has to be humble in trying to predict the cash rate peak. Prior to the December quarter CPI release we thought the RBA would leave rates on hold at this month’s meeting! And some argue there are still many hikes ahead of us. So, it’s worth considering both sides of the argument.
Case for higher interest rates
Inflation in Australia is still rising.
The labour market remains very tight.
Against this backdrop and given the 1970s experience the RBA needs to keep demonstrating its resolve to get inflation back down to keep inflation expectations down – otherwise it will get harder to tame.
As a result several economists expecting the cash rate to rise above 4%.
The case for rates being near the top
Monetary policy operates with a lag. It takes 2-3 months for RBA rate hikes to impact actual variable rate mortgage payments and then several months before this impacts spending.
Inflationary pressure is easing globally.
There are signs Australian inflation is peaking with business surveys showing a downtrend in input and output price readings, low work backlogs & a falling capacity utilisation. Reflecting this and global indicators, our Australian Pipeline Inflation Indicator is falling sharply.
Some of the components which drove inflation so high are unlikely to be repeated: the 10.9% December quarter rise in travel costs will start to fade as travel and travel industry capacity return to normal; dwelling purchase costs (up 18%yoy) are now slowing; petrol prices appear to be stabilising; and electricity prices this year may be lower than previously expected with falling gas and coal prices.
Given the almost three-fold increase in the household debt to income ratios over the last 30 years, a 17% mortgage rate in 1989 – which preceded the early 1990s recession – is roughly equivalent to a 6% variable mortgage rate today and we are already pushing through that.
There is increasing evidence rate hikes are getting traction: housing related indicators are all very weak; the 9% fall in home prices will depress consumer spending via a negative wealth effect; consumer confidence remains depressed; retail sales are falling in real terms; and there are some signs of slowing jobs growth. Slower demand in the economy will further reduce inflationary pressures.
Concluding comment
Base case is now for one more 0.25% hike next month, followed by a lengthy peak as it becomes clearer that inflationary pressures are easing and growth is slowing, ahead of the start of rate cuts late this year or early next year.