A doctor friend once described the process of chemotherapy to me like this: You’re basically trying to kill the cancer faster than the treatment kills the patient. In this sense, interest rate hikes are a lot like chemo.
While the Reserve Bank of Australia (RBA) continues to hike up the cost of borrowing, mortgage holders cling on for dear life, hoping the economic illness of inflation will be thwarted before they succumb to the bank’s harsh measures.
Interest rates rose for a historic 12th time on 6 June, the second consecutive rise following a brief respite in April. The cash rate now sits at 4.1%, climbing another 25 basis points from its COVID-induced lull of 0.1%. Since May of last year, the cash rate charged by the RBA to the banks has risen by 4%, bringing it to the highest it’s been in over a decade.
Mortgage holders are already struggling to pay the current high interest on their loans. With the additional rise, the average mortgage of $585,101 will now cost an additional $15,840 per year to service. This works out to an additional $1,320 per month that homeowners will have to fork over and that’s if they’re still locked in at the lowest pre-COVID loan rate of 1.7%. Many are not and are subsequently paying far higher rates.
The RBA has said in a statement explaining the decision that “Inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range.”.
“This further increase in interest rates is to provide greater confidence that inflation will return to target within a reasonable timeframe.”
Any hopes that this pain might end soon have been dashed by additional RBA comments that “some further tightening of monetary policy may be required”.
Some experts have predicted that this may be the last interest rate rise for the next few months, although a further rise is expected before September. Others think that rates will continue to rise until inflation really starts to fall, even as the RBA starts running into upside pressures of rising rates like slowing productivity.
The comparison site Finder revealed in their latest cost of living report that nearly 80% of Aussies have cut their spending in order to cope with rising costs. As Graham Cook, head of consumer research at Finder, has said, “the RBA’s latest hike is likely to push that closer to 100%”.
Why Do Interest Rates Rise?
The main driver behind the rate rises is the RBA’s desperate need to keep inflation in check. Cost of living pressures, whereby everything is getting more expensive, can only be brought under control if the bank is able to curb demand. That means making everyone poorer in the short term to avoid making everyone extremely poor in the long term.
Of course, other factors are at play when it comes to inflation, notably the disruption to global markets caused by the war in Ukraine, as well as the logistical and economic hangover from the COVID pandemic. These are things the RBA, powerful as it is, has no control over. So, they hit the only button they have: The rate rise button.
How Long Will Interest Rates Rise For?
This is fairly uncharted territory for the RBA. Or, at the very least, it’s been a generation or two since we’ve experienced this. You’ve got to go way back to 1994 to see interest rates rise as sharply as they have in the past year.
Back then, as ever, interest rates were hiked to stamp down inflation while promoting growth, which it was able to do.
The problem is that 1994 was a very different time to 2023. Average household debt is much larger now than it was back then, while more people owned their own homes. Precarious living was not so common and it seems like the current plan of attack has a much higher chance of tipping the economy into recession. In addition, raising interest rates only affects certain sectors of society while doing little to curb the spending of others.
While raising interest rates is tried and tested monetary theory, it’s also the only option that central banks have. Some critics have said that the RBA could be acting based on historical factors that no longer apply, and the economy is showing signs of danger. Gross domestic product figures, released at the start of March, show that spending in the Australian economy is actually going backward while our imports have slowed down. In short, the economy is grinding to a halt.
This is made worse by the fact that, by March, only 60% of mortgage holders had been impacted by the changes, according to Commonwealth Bank data. Those are the people who were still on fixed-rate mortgages from before the rate rises that have yet to expire. The RBA predicts that half of those mortgages will expire later this year, between now and September, referred to by some as the ‘mortgage cliff’. When the impact of the interest rate hikes hit, the impact on the economy will be “swift and severe,” according to the ABC’s business editor.
As for how long this situation will hold for, well, a majority of economic and financial experts polled by Finder indicated that they expected interest rates would peak at 4.17%, indicating a further 0.05% increase before September.
In 1994, the RBA held the newly raised interest rates in place for nearly 18 months before they slowly reduced them over the following year or so. During other periods of sharp rise, like the 1999/2000 rate rise, those numbers only held for around six months. Similar scenes occurred in 2010 when sharply spiked rates held for around a year.
The silver lining though is that the RBA has assessed that inflation has peaked in Australia. Recent Australian Bureau of Statistics (ABS) figures tracked CPI inflation at 8.4% in December. Following the post-holiday lull, inflation in March was tracked at 6.3% year-on-year.
However, that downward trend was bucked in April when CPI inflation was measured at 6.8%, a slight climb on March’s figures. It’s this that has the RBA concerned, prompting the latest rise.
However, Cooke has said that “the flood waters should start to subside” soon, citing economists they have polled who believe inflation will start to creep downwards, hitting the RBA’s target of 2% by June of next year.
“Inflation has bumped up a tad in April, but is still well below its December peak. The long-term forecast from our panel is for inflation to continue to decline, which should mean the cash rate does too,” Cooke said.
That being said, this means we’ve all got to deal with paying those current high prices for goods and services for a while yet.
Corporate Profits Driving Inflation?
While the ABS has put still-high inflation down to rental increases and holiday spending, the Australia Institute has pointed the finger at sky-high corporate profits. Their recent report says that 69% of current inflation can be traced back to increased corporate earnings.
Australian businesses increased their prices by a total of $160 billion per year up to September of last year, “over and above their higher expenses for labour, taxes, and other inputs, and over and above new profits generated by growth in real economic output”.
“Without the inclusion of those excess profits in final prices for Australian-made goods and services, inflation since the pandemic would have been much slower than was experienced in practice: an annual average of 2.7% per year, barely half of the 5.2% annual average actually recorded since end-2019”.
They state that if companies weren’t being so greedy, inflation would have already fallen within the RBA’s target, and further rate hikes would be unnecessary.