Is the RBA done with interest rate hikes?

CBA economics head discusses forecast

Is the RBA done with interest rate hikes?

The official cash rate has risen 300 basis points this year in an effort to control inflation, yet a prominent CBA economist thinks the Reserve Bank has not quite finished the job.

CBA head of Australian Economics Gareth Aird (pictured above) said the bank had revised its peak cash rate forecast to 3.35%, with one further 25-basis point hike in February 2023.

He noted a tweak in the RBA’s forward guidance in December, with RBA Governor Philip Lowe saying in the December policy statement that the board expected to increase interest rates further over the period ahead, but that it was “not on a pre-set course”.

Explaining CBA’s forecast, Aird told MPA that much of the data on economic activity did not yet reflect the impact of the eight OCR hikes announced this year.

Acknowledging that 300 basis points of increases from May to December was “pretty extraordinary”, Aird said that the RBA was likely to be close to the end of the current tightening cycle.

“The RBA basically said [on December 6] they’re still expecting to increase interest rates further, and we’ve got that one additional rate hike in there,” Aird said.

Commenting on the slight drop in the inflation rate, from 7.3% in September to 6.9% in October, Aird said it was still too early to assume that the rate of inflation had peaked.

CBA was expecting annual inflation to go a little higher – as was the RBA, he said.

“It was encouraging to see some data (albeit one month’s data), that suggested the pace of inflation had actually slowed,” Aird said.

He also pointed out that in its December monetary policy statement, the RBA referred to the October inflation figure, noting the change in reporting with a new monthly CPI indicator.

“We weren’t sure how much weight the Reserve Bank was putting on it, but the fact that the governor referenced the rate of inflation from that October survey means that they’re clearly looking at it,” Aird said.

Noting that inflation data was just one aspect of the RBA’s assessment, Aird said that the October inflation result was unlikely to have changed the course of the RBA in announcing the 25-basis point rise in December.

A further indication of the RBA’s next move would be provided in the December Board minutes, to be released next week.

“Based on the tone of the governor’s statement last week, we’re thinking in their minds, they’ve got a little bit more to do in terms of rate rises, but not too much more,” Aird said.

CBA was not forecasting a recession in 2023, noting that unlike the situation in New Zealand, the central bank said it wanted a soft landing. But Aird acknowledged that further rate hikes would increase the probability of a recession occurring.

“Our thinking here is that if they don’t deliver too much more in the way of hikes, then Australia will avoid a recession,” Aird said. “But it’s becoming increasingly difficult, the more they take the cash rate up.”

The impact of 2022 cash rate rises on borrowers

The official cash rate, now 3.10%, has risen eight consecutive times this year. According to CBA, there is around a three-month lag from when the official cash rate is announced, to when a borrower on a floating rate mortgage experiences the impact on their cashflow. 

While the total increase was likely to be a “significant shock” for many Australian households, particularly those coming off lower fixed rates, Aird said it was also important to put those rises into context of how low interest rates were at the start of the current cycle.

“I think it’s very easily forgotten that the cash rate was just 0.75% pre-pandemic,” Aird said.

He acknowledged that many borrowers had taken on a large chunk of debt, based on very low mortgage rates, which dropped further (to 0.10% in November 2020) over the COVID-19 pandemic.

Due to the Reserve Bank Term Funding Facility, Aird said fixed rates were at record lows.

“We’ve had lots of lending taking place at very low interest rates, that have gone up by 300 basis points so that percentage change in the mortgage rate is incredibly large. That’s what drives the interest cost on debt.”

A borrower who was on a mortgage rate of around 2.50% before the RBA starting hiking, would now be looking at a mortgage rate of around 5%, so their interest cost had effectively doubled, he said.

Aird also said that the rapid succession of rate rises had “caught households off guard”, given that throughout 2021, the Reserve Bank had indicated that interest rates wouldn’t rise until 2024.

“Many of them [borrowers] will experience the full impact of what the RBA has done as we go through next year, either because they’re on a fixed rate that’s going to roll off, or they’re on a floating rate where there’s that lagged impact coming through on their mortgage repayments,” Aird said.

He also pointed out that the three-month lag between when an official cash rate rise was announced and the impact on variable rate borrowers referred to the cashflow impact, as opposed to the interest charged.

Using the example of retail trade data, Aird said the three months of rate hikes had not yet been picked up in the current figures.

“We’ve been looking at an economy that’s not capturing the impact of the already delivered rate hikes, but we will see that as we go through next year.”

The official cash rate has often been referred to as a “blunt instrument”. It affected household and business borrowers, particularly households with mortgages, and demand for credit.  There was also an impact referred to as the “wealth effect”, where homeowners without mortgages were less inclined to spend after the value of their home had fallen.

For commodities such as petrol and electricity, where prices were influenced by outside forces, official cash rate hikes had little effect.

Where official cash rate hikes got the most bang for their buck was on discretionary spending within the economy, Aird said.

“Those households that are experiencing the biggest increase in their mortgage repayments will be the ones that have to adjust their spending the most.”