The Reserve Bank of Australia (RBA) has increased interest rates this month by 0.5 percentage points, making the new cash rate 1.35%.
It is the third rate rise in three months.
Here’s a recap of what happened and what it means.
Why are they raising the cash rate?
The RBA is raising rates to slow down, but not stop, household spending to slow the inflation rate.
If more people are more disinclined to spend money, there will be less demand for goods and services, driving prices down.
It’s also important to remember that the RBA dropped interest rates to record lows to protect the economy from the impacts of the COVID pandemic.
Interest rates were always going to go back up.
Reserve Bank Governor Philip Lowe believes that:
“The resilience of the economy and the higher inflation means that this extraordinary support is no longer needed.”
Were we expecting this rise?
Yes. Economists forecasted July’s 0.5 percentage point rise off following the hike by the same amount in June.
In May, rates were raised by 0.25 percentage points.
How much higher could the cash rate get?
In June, Mr Lowe flagged that interest rates could get to 2.5% at some point, but it’s unclear when that would happen.
He said that the RBA board expects to take further steps in normalising fiscal conditions in Australia over the coming months.
“The size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market.”
Following the July announcement, ABC finance reporter Alicia Barry said the RBA might have been initially trying to “front-load” rate rises. Hence, the consecutive 0.5 percentage point rises could scale back to rate rises of 0.25% increments in future.
Barry also mentioned how high-interest rates would affect how well the economy withstands this and whether we start talking about recession.
Is Australia going to go into recession?
ABC business editor Ian Verrender believes there is a strong chance Australia will go into recession. Still, it’s hard to say when a recession is an actual possibility because, whenever the central banks globally have tried to put a halt to inflation, it has often resulted in a recession.
Who’s going to be impacted most by this cash rate rise?
The Treasurer, Jim Chalmers, was managing expectations ahead of July’s announcement, saying households would face difficult conditions for the rest of the year. It was essential to be forthcoming with people regarding that reality.
Market analysts intimated the cash rate could end up somewhere between 2% and 3% as the RBA attempts to diminish surging inflationary pressure in the economy. Chalmers warned that the latest increase “won’t be the last this year”.
Verrender says it will most likely be younger, first-home buyers that will feel the most impact:
“It’s the first-home buyers who got in last year who are the ones who are … looking at quite a lot of angst in the future here.”
While many homeowners are on fixed rates, and they probably don’t run off for another year or two, they are looking at huge increases in their repayments once they roll off.
The more recently you have entered into the housing market and the younger you are, the more extreme the negative impact will be.
Will this impact people who do not have a mortgage?
Chalmers recognised in a rising interest rate climate, a more significant proportion of household budgets, which are feeling the pinch caused by the price of petrol and groceries and electricity and other essentials, would be consumed by mortgage repayments.
He said the RBA was raising the cash rate because we have high and rising inflation, and that’s why they have deemed these problematic decisions necessary.
ABC business reporter Gareth Hutchens said that when the cash rate increases, it affects different people differently, even if you don’t have a mortgage.
Do you have a personal or car loan with a variable interest rate? If you do, your lender may decide to increase the rates on those loans by a small amount. Alternatively, if you have a savings account, the interest rate on your savings could increase, which is positive
“The interest rates on credit cards don’t typically respond to changes in the cash rate, but they’re exorbitantly high, regardless of what the cash rate is doing,” the Treasurer said.
Is inflation rising too?
All signs point to yes.
Global supply chain issues and increasing energy prices are fuelling the current trend that could result in inflation reaching 7% by year’s end while the unemployment rate has fallen to record lows.
Lowe said that the bank’s expectation was inflation would peak this year before declining back towards 2 to 3% in 2023.
The RBA governor stated that higher interest rates would assist in establishing a more “sustainable balance between the demand for and the supply of goods and services.”
Currently, the inflation rate is sitting at 5.1% but that’s only for the 12 months to the March 2022 quarter.
We won’t hear about the June quarter until July 27.
The Australia Bureau of Statistics calculates the inflation rate based on the prices of a basket of standard items across 11 categories, such as food and non-alcoholic beverages, housing and transport.
The Treasurer said the next few months of households pressured by rising prices and higher borrowing costs would be difficult.
He said the problematic conditions would moderate. Although, they were currently finding it sufficiently challenging to require institutional interests in the economy (governments, unions, businesses) to cooperate and find common ground.
Chalmers said he had discussions with the retail banks several times since being sworn into the treasury portfolio post-election. He was seeking advice concerning the exposure of households to increased borrowing costs.
He said the banks had advised him that some customers had used the spending limitations, inflicted by the pandemic, to pay down their mortgages, but others were “right on the margins”.
The Treasurer said that rising rates were particularly painful for Australians in the latter category. But even for people who have a buffer, every half a per cent that interest rates increase, if you’ve got a $500,000 mortgage, that’s about $137 a month that you need to find in your family budget”.
It will be a difficult day. For many Australians, there will be some disturbing and challenging news.
The rising interest rate climate has already harmed house prices. CoreLogic’s home value index has declined for two consecutive months, with the national decrease in home values driven by sharp monthly falls in Sydney (-1.6%) and Melbourne (-1.1%).
Chalmers also made it clear the latest flood catastrophe in NSW would require further demands on the budget. Subsequent to coordinating disaster relief and activating defence force personnel, the Treasurer was transparent that the government was contemplating activating $1,000 immediate cash for people displaced from their homes.
What about investors?
The fact that the RBA has joined the Federal Reserve and other central banks in front loading more extensive rate hikes to combat inflation are positive news for AUD cash investors. However, following the rate hike, time deposit and repo rates will likely reset higher. Although, high inter-bank liquidity indicates commercial banks may not pass through the entire hike to depositors.
Finally, market volatility is likely to remain elevated with the market pricing in faster and more significant rate hikes while the RBA emphasises its data-dependent stance. Therefore, we believe investors should take a cautious approach to cash management, ensuring good segmentation and diversification to optimise the risk and return opportunities.
Vogue Advisory Group – helping our clients protect their wealth
If you would like to find out more about cash and interest rate rises, please contact the team at Vogue Advisory Group.