Prime Minister Anthony Albanese has warned the Reserve Bank of Australia (RBA) not to “overreach” amid indications of an imminent rate rise. The RBA is seemingly set to lock horns with the Australian government amidst the cost of living crisis. So what is the short to medium-term prospects for Australian interest rates?
Overly cautious on the way down
The RBA has recently admitted it was overly cautious and “overinsured” the Australian economy in light of Covid. Unfortunately, this error was compounded when the RBA recently suggested that base rates remain relatively low until 2024 – before the interest rate rises. Now, the governor of the RBA, Philip Lowe, believes that base rates could increase to 2.5% in the coming months. The rate currently stands at 1.35% after increases in May and June.
As seems to be the trend with central bank forecasts, analysts are well out of sync. The current consensus suggests that Australian interest rates will rise to 3% in the coming months, impacting household budgets and economic activity. In reality, many believe this figure could be exceeded!
While Albanese needs to be seen to be on the side of the electorate, even he has admitted these are challenging times. When the RBA announced that rates would likely remain low until 2024, nobody could have guessed the impact of the Ukraine/Russian war and the cost of living crisis.
Inflation in Australia currently stands at 5.1%, the highest level for circa 20 years. While this compares favourably to the UK rate, approaching 10%, many expect Australian inflation to continue rising in the short to medium-term. Politicians and bankers appreciate that increasing interest rates makes borrowing more expensive, reducing lending and impacting consumer spending. Reducing general consumer spending removes much of the pressure on prices and should slowly but surely bring inflation under control. However, the global energy crisis is unlikely to be as quickly resolved!
How high could interest rates go?
David Planck, ANZ head of Australian economics, has a much more pessimistic view of Australian interest rates. He believes we could see 0.5 percentage point increases in August, September, October and November. However, there is also an outside chance that August or September could see a 0.75 percentage point increase. This would push rates to between 3.35% and 3.6%, significantly higher than the RBA’s “neutral target” estimate of 2.5%.
To put this into perspective, on the average Australian mortgage of $600,000, a 2% increase in mortgage rates equates to an extra $708 monthly. So when the economy slows, piling additional mortgage costs on households across Australia is unhelpful.
Politics and finance
While ultimately, the RBA has the final say on interest rates, Governor Philip Lowe is under massive pressure from the government. In a move seen by many as slightly unfair, recent contradictions and miss readings of the market by the RBA were highlighted by Prime Minister Anthony Albanese. This does not bode well for an amicable working relationship!