RBA 0.5% Rate Rise Seen As Necessary Step In Normalizing Rates

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RBA 0.5% Rate Rise Seen As Necessary Step In Normalizing Rates

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The rate rise we had to have………………

Yesterday’s half of one percent rise in official interest rates is a further necessary step in the withdrawal of the extraordinary monetary policy support that was put in place by the Reserve Bank (RBA) to assist the Australian economy through the pandemic. The official cash rate now sits at 0.85 percent. The 0.5 percent increase is the largest official rate rise in nearly 22 years.

Record low interest rates are not consistent with developments occurring throughout the world at present, according to the RBA. High domestic energy and food prices following the war on Ukraine, supply chain and production disruption related to the spread of COVID in China and high core inflation in other economies, forced the RBA’s hand. The RBA noted that inflation has picked up faster and to a higher level than previously expected. According to the RBA, inflation sources are broadening. Firms are increasingly passing on cost increases arising from supply chain pressures at a time when consumer demand remains strong, while higher living and new dwelling costs are pushing up prices.

On this basis, a half a percent rate rise is warranted at this time. The bond market was telling us we had an inflation problem well before it showed up in government data and before Governor Phillip Lowe acknowledged that inflation was building around the world and in the Australian economy. Governor Lowe’s statement yesterday acknowledged this point when he said that the inflation outlook is materially higher than envisaged three months ago.  The RBA was previously behind the interest rate curve and the magnitude of yesterday’s half a percent rate increase suggests that the RBA is in catch-up mode to achieve a rate setting today that should have been in place months ago. Hindsight is a wonderful advantage; however, the RBA is doing what is necessary, and that includes changing its outlook when the facts change, which is what has occurred this week, at the RBA.

Part of this problem can be explained by the fact that Australia is only one of two OECD nations that compile its consumer price index data quarterly, rather than monthly. The other nation is New Zealand. This means that when the consumer price index data is published, many of the measures that comprise the data are months old and won’t be updated again for another 3 months.

What is the impact?

The impact of rising interest rates on homeowners with a mortgage is significant. A 50 basis points rise on a $500,00 mortgage adds about $120 per month to home loan repayments. Successive interest rate increases over the coming 12-months could increase this repayment amount by $600 - $800 per month, for a homeowner with a $500,000 mortgage.

For first-time homeowners, the impact of higher mortgage rates is especially severe. A new mortgage to buy an entry-level home in Australia’s most populated state of NSW is now around $700,000. New homeowners could be paying about $800 a month in additional loan repayments a year from now, based on current market expectations of where official interest rates may settle.

This impost is likely to place a dampener on new housing demand in Australia. The impact of less housing demand on the Australian economy is potentially significant. This reason is because housing demand IS the business cycle in Australia, given its higher multiplier effect compared to other economic activity such as mining and manufacturing. Housing is also labour intensive, and a slowing of house construction activity tends to reduce employment levels.

Looking ahead. The RBA now expects headline inflation to peak at around six percent in the second half of this year and to return to the top of the two to three percent target range in 2024. The RBA expects the Australian economy to expand by four and a quarter percent over 2022, and moderate to a two percent growth rate over 2023.

Nowhere in these forecasts is a mention of economic recession.

While the RBA’s tightening monetary policy stance has only begun, the RBA appears to have a clear line of sight over inflation and the strength of the Australian economy, over the next two years.

Governor Lowe reiterated yesterday that the RBA Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. He went on to say that this will require a further lift in interest rates over the period ahead.

Rational investors know that the war on Ukraine will end, supply chain disruption can be managed, and nothing cures high prices faster than high prices.

Markets appear accepting of the monetary policy approach currently adopted by the RBA Board, who now have a closer handle on the inflation outlook and confidence that a resilient Australian economy has the capacity to weather the issues currently confronting the world.

Louis Mosmann

Louis Mosmann is a Private Wealth Client and Research Assistant at KOSEC- Kodari Securities. Louis covers macroeconomic events, global markets and ASX300 company announcements, allowing clients to make more informed investment decisions. Email Louis at l.mosmann@kosec.com.au.

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