As predicted yesterday by many economists, the Reserve Bank of Australia (RBA) has increased interest rates. As a result, the cash rate has reached its highest level since 2015. This is a significant shift from just above 0% in May 2022 to the current level of 2.35%. It is also the fastest increase in the Australian base rate for almost 30 years.
Inflation is still front and centre
Philip Lowe, governor of the RBA, has been putting more meat on the bone for investors and economists. The long-term target inflation rate between 2% and 3% remains, but the suggestion that the RBA could do this while “keeping the economy on an even keel” appears somewhat optimistic.
While UK inflation is expected to peak anywhere from 13%, Australia’s situation is slightly different. The RBA and the Australian Treasury believe that inflation will top out at around 8% towards the end of 2022. However, even the most optimistic of observers appreciate there is only a narrow window of opportunity to reduce inflation while maintaining at least some degree of momentum with the economy.
Looking at the broader situation, there is no doubt that global pressures have made a difficult situation even more challenging. There are numerous issues to take into consideration, such as:
- The aftermath of the Covid pandemic
- Global tightening of monetary policy
- The Russian invasion of Ukraine
- Increase in energy costs
- Cost of living crisis
Even though many of these issues are beyond the control of the Australian central bank, it is becoming clear that many central banks were slow to react to the threat of inflation. Once this juggernaut gained momentum, it was obvious it would take some time to bring it back under control. The target range of between 2% and 3% is similar to many other central banks worldwide, but it could be some time before inflation is anywhere near these levels.
Outlook for interest rates
A few weeks ago, most economists forecasted that Australian base rates would top out at 3%. Fast forward a few weeks, and this figure has now increased to 4%, which will significantly impact personal debt and mortgages. While Philip Lowe admitted he expects further interest rate rises, he said this was “not on a pre-set path”. What does this mean?
The impact of rising interest rates always takes some time to filter through to the economy, even if it can immediately affect consumer confidence. Consequently, many believe the RBA is trying to tell the markets that a pause in interest rate rises is on the cards in the short term. This would give time to monitor and measure the impact of recent changes and allow a more accurate analysis of what needs to be done.
More pain on the way
Whether, as seems likely, the speed at which interest rates are rising will slow, there is undoubtedly much short-term pain to come for consumers and businesses in Australia. Until inflation is under control, it is difficult, if not impossible, to put policies in place to support the economy in the short term. Historically, Australia has proven to be more robust than many global economies, but the next few months will undoubtedly be challenging.