The Cash Rate and You
Reeva Cahyadi and Stephen Liu
Following the rapid surge in COVID infections during the 2020 March quarter, the Reserve Bank of Australia (RBA) responded by adjusting its monetary stance to counter the economic and financial disruptions. As such, the RBA implemented extensive measures to lower funding costs and influence the supply of credit to the economy, which led to the lowering of the cash rate twice in March 2020, to 0.25 per cent and again in November 2020 to 0.1 per cent. Following 16 months of the same 0.10 per cent cash rate target, the RBA decided to increase the cash rate up 25 basis points to 0.35 per cent during May 2022, then again by 50 basis points to 0.85 per cent during June 2022. In the most recent meeting in July, the RBA again decided to increase the official cash rate by 50 basis points to 1.35 per cent, following fears of high inflationary pressures present within the Australian economy.
What is Monetary Policy?
The RBA implements monetary policy as a counter cyclical tool to aid in achieving macroeconomic objectives of price stability, full employment and sustainable growth. The RBA board meets monthly, to discuss revised targets for the cash rate, which itself is the rate of interest charged on overnight loans between private intermediaries (banks) and the Reserve Bank itself.
Why did this change occur?
With reference to the RBA’s recent monthly board meeting concerning its stance on monetary policy, the following factors have been outlined for consideration regarding the cash rate:
- The ongoing inflationary pressures caused by global factors, including COVID-related disruptions to supply chains and the ongoing conflict in Ukraine, are causing petrol prices, electricity and food in Australia to increase in price. Additionally, constraints in certain sectors and floods both earlier in the year and the most recent natural disaster have continued to place growing pressures on inflation through disruptions to food production, damage to public infrastructure and damages to personal assets such as homes and cars. As such, these factors have driven inflation above the target range of 2 to 3 per cent to 5.1 per cent in the Mar 2022 quarter (according to the ABS).
- Additionally, strong economic growth at 0.8 per cent during the March quarter (3.3 per cent for the year) and a strong labour market with unemployment at 3.5 per cent, which is the lowest rate in over 50 years, have allowed the RBA to focus on alternative objectives, specifically the price stability (inflation). Although, it must be mentioned that even though unemployment is currently at a record low, it also signifies that the economy is operating in inefficiency, especially with the Fair Work Commissions' decision to increase the national minimum wage by 5.2 per cent to support low-paid workers during a period of higher inflation, attributing to excess supply in the labour force.
- Furthermore, the Australian government's excess stimulus payments of approximately $1 trillion from the pandemic, all from borrowing, and the RBA’s quantitative easing (QE) have now caught up with Australia’s budget as gross debt is forecasted at 39.5% of Gross Domestic Product (GDP) in 2021-22 (according to the budget overview).
- With exports jumping 9.5%, the Australian economy has continued to widen its record-high trade surplus of A$15.97bn. This can be attributed to strong performances across the export base, with recent surges in mineral commodities. This is exemplified in coal rising 20%, increasing overall resources exports receipts by 12%, with additional gains in gold, natural gas and iron ore. This growth is further bolstered with increased tourism, supporting service exports.
How does it affect you?
Interest rates are the cost of borrowing, so when the Reserve Bank raises the target rate, money becomes more expensive to borrow.
Since the Reserve Bank’s second rate hike, it is expected to add about $133 a month to the cost of the average Australian mortgage. ANZ has revised its cash rate target for the end of this year to 3.35 per cent, now the highest of the big four banks. To get to this level, the bank predicts that the RBA will raise rates by 0.5 per cent in August, September, October and November. If the forecasts by the Treasury and the RBA themselves of inflation hitting 7 per cent or more are correct, this would mark the highest level of Australian inflation since the RBA defined its inflation target almost 30 years ago. This increase in interest rates would result in some families struggling to meet higher repayments over the next two years.
In the past year alone, home prices have outstripped income growth by almost 400% (BLS). With the pandemic creating incentives for the housing market rather than crashing it, the historically low mortgage rates ushered by the government's response towards COVID recession resulted in investors (both domestic and international) heavily saturating the housing market. With these prices substantially higher than underlying fundamentals, consumers are hit as a result.
When interest rates are higher, fewer people can afford homes, and fewer businesses can afford to invest in a new factory and hire more workers. As a result, higher interest rates can slow down the economy's growth rate overall while also curbing inflation. This is because higher borrowing costs disincentivise consumers to spend, resulting in more cash held within bank accounts, tightening the money supply. This causes a demand for goods, making them cheaper and, in turn, lowering inflation.
Ultimately what it means for consumers and everyone will depend on whether the pace of inflation slows as much and as quickly as the Reserve has been forecasting.
Recent interviews with Dr Phillp Lowe have indicated that Australians “need to be prepared for higher interest rates”. Together with the RBA's latest prediction that the OCR will be expected to peak at around 2.5 per cent, with the expectation that interest rates will continue to rise as long as inflation continues to increase. However, with predictions that inflation will continue to rise to approximately 7 per cent by the end of 2022 and unlikely to fall until early in 2023, any hopes of the OCR falling are extremely unlikely bar any economic or social disasters. As a result, mortgage prices could fall exponentially. According to an analysis by fund management firm Coolabah Capital, housing prices could fall by up to 31% if the RBA cash rate peaks at 4.25%, exemplifying the extent of potential impacts on households.