Economists share their views
After five back-to-back official cash rate rises, there is now a question of whether the RBA should pause while the impacts flow through to borrowers.
In what has been the fastest tightening cycle since 1994, as widely expected by economists, the RBA delivered a half a percentage point hike on Tuesday – the fourth 50-basis point increase in a row. The official cash rate now sits at 2.35%, the highest point since April 2015.
Although interest rate rises are necessary to rein in inflation and return monetary settings to a normal range, not all economists agree that rate hikes should continue at the same pace.
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MPA spoke to three economists, who indicated that the RBA is unlikely to pause interest rate hikes before Christmas. They cited ongoing inflationary pressures, with inflation being at the highest level since the early 1990s, the lagged effect of official cash rate rises on borrowers’ repayments, and robust household spending.
The RBA’s central forecast is for inflation to peak around 7.75% over 2022. Current ABS figures show annual inflation reached 6.1% in June.
In raising the official cash rate, the RBA aims to reduce demand pressures within the economy through a reduction in household spending. A reduction in prices would bring inflation back towards its 2% to 3% target range.
The behaviour of household spending remains an “important source of uncertainty”, RBA deputy governor Philip Lowe said in the September monetary policy statement. Higher inflation and higher interest rates are “putting pressure on household budgets”, with the full effects of higher interest rates “yet to be felt in mortgage payments”, he said.
Economists MPA spoke to said there is around a three-month lag before changes in the official cash rate flow through to variable rate mortgages. This indicates borrowers will start to feel the pinch of the May to September rate hikes by Christmas.
AMP senior economist Diana Mousina (pictured above left) said while the RBA would usually display more patience in reassessing the economic situation and data after changing interest rates, it was concerned inflation was too high and would continue to be elevated unless it moved swiftly to tighten monetary policy.
One of the challenges of inflation data is that it is backward looking: the annual number of 6.1% for the June 2022 quarter captures the strength of the economy after reopening following the Omicron variant COVID wave, including high consumer demand for goods, she said.
Consumer spending (up 18.4% year-on-year, according to ABS July figures), looked to be plateauing, Mousina said, but it was “not collapsing yet”. Households collectively have around $250bn in savings buffers, which they accumulated over the COVID-19 pandemic, she said.
Consumer services spending was still normalising from the COVID-19 related slump, and there were lags between when monetary policy changed and that was reflected in mortgage repayments, she said.
“For the RBA to hold off on hiking rates in November I think the data would need to turn (to the downside) very quickly which means a rise in the unemployment rate, larger falls in home prices and declines in retail spending: this looks unlikely to happen with a month,” Mousina said.
AMP’s current forecast was for the cash rate to peak at around 2.85% by the end of 2022, slightly lower than market pricing. But there was a risk that the cash rate gets to 3.1%, Mousina said.
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PropTrack senior economist Eleanor Creagh (pictured above centre) said the approximate three-month lag between rate hikes and variable mortgage repayment increases partly explained why spending remained robust, while consumer confidence had fallen.
“Given the lagged effect of rate rises, [the] large share of variable rate borrowers ahead on repayments and borrowers on fixed terms yet to expire, many mortgage holders are yet to see their minimum repayments increase,” Creagh said.
“As this changes and households are forced to make budgetary adjustments, discretionary spending will likely slow and economic data will begin to reflect this, giving the RBA cause for pause.”
The RBA is approaching a point where erring on the side of caution may be appropriate, Creagh said. But this was offset by the unenviable task of taming inflation pressures and keeping inflation expectations anchored. The RBA had noted several times the challenge of keeping the economy “on an even keel” while returning inflation to its target range.
“As spending slows, along with easing inflation pressures into year end, the Reserve Bank may find it appropriate to pause or at least slow the pace of rate hikes. Already commodity prices have pulled back, logistics and supply strains are easing, and freight costs are lowering, suggesting that some of the contributors to inflation pressures are easing off,” Creagh said.
The RBA said in the September monetary policy statement that it expected to “increase interest rates further over the months ahead” but also said it was “not on a pre-set path”. Incoming data and the board’s expectations of the inflation outlook and the labour market would guide the timing.
“The language is perhaps an indication that the RBA is not likely to hold off in October unless there is a material change,” Creagh said.
CreditorWatch chief economist Anneke Thompson (pictured above right) said the RBA expected inflation to increase further over the months ahead. This was due to the combination of global economic pressures, tightening monetary policies in most countries, the war in Ukraine and COVID-19 containment measures.
Inflation continued to impact the real wages of Australian employees: based on ABS Wage Price Index data, real wages had been in decline since June 2021, she said. The high savings rate meant many Australians had not felt the impact of this drop immediately, but the total savings rates of Australians is now also starting to drop.
“This means that many people are now using their savings pool to meet higher interest repayments and the general higher cost of living and it’s a clear indicator that we’re starting to see the impact of the rate hikes on Australian households,” Thompson said.
CreditorWatch doesn’t expect the RBA to hit the pause button on cash rate increases until retail trade data starts to better reflect downbeat consumer sentiment. This isn’t likely to happen before the Christmas shopping period, she said.
“It is likely by December that mortgage holders will be really feeling the effects of higher repayments, and of course higher prices of everything from furniture, to eating out and to holidays,” Thompson said.
Consumer sentiment has been tracking downwards: its descent started around five months after real wages turned negative, she said. The Westpac Consumer Sentiment Index has fallen by 22% since November 2021.
“Understandably, respondents with a home loan recorded the biggest drop in sentiment. Their confidence fell by 8.9% compared to modest moves from tenants (0.2%) and those owners who do not have a mortgage (-2.1%),” Thompson said.
The RBA would be keeping a close eye on consumer confidence, house prices and employment data (people employed, hours worked and wage growth) over the coming months.
“While it is highly likely that the cash rate will rise further, the medium to longer term outlook is moderating. This assumes however, that supply side issues can begin to resolve themselves,” Thompson said.
“Unfortunately, luck and other factors outside the control of the RBA will tell the story there.”
