After starting 2022 at just 0.1%, the official exchange rate is now 2.6%. Since the Reserve Bank of Australia (RBA) began raising the cash rate in May 2022, there have been six interest rate hikes this year, totaling a combined total of 2.5%.
The hikes came despite RBA Governor Dr Philip Lowe indicating during the Covid-19 pandemic that official interest rates were unlikely to rise before 2024.
On this basis and coupled with a prolonged period of historically low interest rates, many Australians have borrowed heavily, taking out large mortgages to cope with soaring house prices. As a result, many of them may be starting to experience mortgage stress.
So what happened?
ForbesAdvisor asked three top economists why rates started rising earlier than expected, if they will continue to rise, what will stop the increases, and when they might start falling.
Why are interest rates rising?
Nicki Hutley, independent economist and economic consultant, Alexis Gray, senior economist for Asia-Pacific at Vanguard and Sarah Hunter, senior economist and partner at KPMG all agree that the RBA is raising interest rates to stem the rise in the inflation.
As Ms. Gray explains, three key factors contribute to rising inflation:
- Pent-up demand as consumers spend what they saved during Covid-19.
- A change in consumption habits with an increased appetite for physical goods that suppliers struggle to satisfy.
- The Ukraine-Russia conflict, which has affected the production of many goods as well as supply chains due to limited oil and gas supplies.
Of these, Ms Hunter says it is the first two of particular concern to the RBA. “In fact, we have a mismatch between domestic demand and supply capacity, which generates inflationary pressures,” she says.
Ms Gray says the headline and core inflation rate is already above 6%, which is well above the RBA’s target range of 2% to 3% to keep supply and demand steady. ‘balance.
The reason interest rate hikes are such an effective tool to bring down inflation is that they affect most Australians.
“Interest rates affect all lending in the economy, whether it’s a mortgage or a business loan. Higher rates make it more expensive to service your loan and therefore force you to cut spending in other areas,” Gray says. She adds that even for those without debt, rising interest rates send a signal to them to become more careful when spending money.
This year’s interest rate hikes came as a shock because interest rates have been so low for so long. The last time the RBA raised interest rates was in 2010 and the last time interest rates rose so quickly in such a short time was in 1994.
“It is important to remember that rates were at historic lows and once the economy proved to be relatively robust post-Covid-19 there would still have been rate normalization. The big question was how far ‘where and how fast, rather than whether rates would go up,’ says Ms Hutley.
Ms Hunter agrees: “It’s not a cycle we’re very familiar with these days, but if you look at the historical record, it’s not uncommon.”
Will they continue to increase?
The three economists agree that the increases will continue. They expect the RBA to raise rates after its Nov. 1 and Dec. 6 meetings.
Ms. Hunter forecasts two more hikes of 25 basis points, which means that the cash rate will end the year at 3.1%.
As for where it goes from there, Ms Gray says the cash rate will eventually hit 3.5% to 4% over the next few months.
What must happen for interest rates to fall?
For interest rates to start falling, not only will inflation have to head towards 2% to 3%, but Ms Hutley says unemployment will have to rise and the economy will have to weaken.
While the United States and Europe are expected to fall into recession and slow the growth of Australia’s main trading partner, China, the impact of global economic conditions will also play a role.
Whether the magnitude and pace of recent rate hikes coupled with a global slowdown could push Australia into a technical recession, equivalent to two consecutive quarters of negative growth, is the subject of much debate.
As Ms Hunter explains, the RBA is “trying to engineer a soft landing, the elusive Goldilocks result”.
“We have some relatively useful fundamentals here that mean the outcome of slowing down but not going back seems to be achievable,” she adds.
Ms Gray is less optimistic, putting the likelihood of Australia avoiding a recession over the next two years at 45%, while Ms Hutley puts the risk of Australia experiencing at least a quarter of negative growth in 2023 at “at least above 50%”. “If we get into a recession, rates will come down faster,” she adds.
The big question is when
Ms Gray says conventional wisdom holds that it takes around two years for interest rate moves to trickle down to the economy and Ms Hutley says providing wages is not enough
increase significantly across the economy, the RBA could begin discussing rate cuts in mid-2023.
But according to Hunter, whether the first rate cut comes in late 2023 or the first half of 2024 will depend on whether there are any unforeseen economic shocks on the horizon.
How low will rates go?
When interest rates start to fall, it is unlikely to be towards the lows Australians have grown accustomed to in recent years.
Ms Hutley says the current level of 2.6% is “probably close to the neutral rate”, while Ms Hunter puts the neutral rate between 2.5% and 3% and Ms Gray at around 3%.
“As a mortgage holder, I might want 0% interest rates, but that means the economy is completely stagnant – we only went there when there was a major crisis, so we really hope we don’t go back,” Ms. Gray said.