Interest rates

How the RBA will raise interest rates, what it means for the housing market

Australia is now alone in blocking a financial decision that could have disastrous consequences for the housing market as we know it.

In recent weeks, the US Federal Reserve and the Bank of Canada have joined dozens of central banks around the world in raising interest rates in an effort to fight inflation.

In October, the Reserve Bank of New Zealand (RBNZ) took the lead in being the first central bank in the Anglosphere to raise interest rates. It was followed by the UK’s Bank of England in December.

Amid this wave of interest rate hikes, Australia’s own RBA was left to top off her best ever rendition of Celine Dion all alonenow that it is the only central bank in the English-speaking world not to raise rates.

Although inflation is well above the RBA’s 2-3% target range and economists predict it will rise significantly, RBA Governor Philip Lowe remains reluctant to raise rates.

As recently as November last year, the RBA insisted that the cash rate would remain at its current crisis level of 0.1%. In the months that followed, he was forced to revise their commentary. In an address to a Australian Financial Review peak earlier this month, Dr Lowe said: “It is plausible that the cash rate will be increased later this year.”

Earlier this week, Dr Lowe further reiterated the RBA’s reluctance to raise rates, saying the RBA “will not respond until there is evidence of widespread price pressures.”

Meanwhile, in the world of bond and interest rate futures markets, a very different picture of the spot rate future is being pictured.

According to the ASX Cash Rate Futures, one rate hike is almost set for June, with four more expected by the end of the year. Looking further ahead, the cash rate is expected to be 2.79% in August next year.

A unique challenge in Australia

With Australians holding the second highest level of household debt in the world, at 119.3% of GDP, the impact of rising rates would be felt much more strongly in Australia than in most developed countries.

When AMP Capital’s chief economist, Shane Oliver, spoke to the Sydney Morning Herald in November, he warned that the high amount of debt held by Australians meant the RBA could only raise rates gradually.

“If the Reserve Bank raised interest rates by 100 basis points in one year, it would push the country back into recession,” Dr Oliver said.

In the United States, before the housing crash that played a major role in triggering the global financial crisis in 2008, household debt peaked at almost 101% of GDP. But unlike Australia where the majority of loans have variable interest rates, the vast majority of loans, even at the height of the US housing bubble, were fixed for terms of 15 to 30 years.

Despite a relatively small proportion of Americans holding variable rate loans, a combination of rising rates and tighter credit was enough to send the US housing market plummeting.

For this and other reasons, the RBA is likely to remain reluctant to raise rates for as long as it reasonably can.

Lagging behind the Anglosphere

Over the next few months, central banks around the world are expected to continue raising interest rates. In the United States, markets are currently pricing in a 65% chance that the Federal Reserve will raise rates by 1% in its next two meetings.

With markets currently not expecting the RBA to raise rates in the coming months, Australia could lag the US by 1% or more by the time the RBA feels comfortable enough. to raise their rates.

Under more normal circumstances, this rate differential could put downward pressure on the Australian dollar and add to inflationary pressures. But with the war in Ukraine and other factors currently supporting rising commodity prices, the RBA may have more leeway to keep rates unchanged for longer.

Elections and a difficult start to the next legislature

Although a rate hike before the next federal election is currently not considered likely, if the inflation data continues to surprise, it is entirely possible that the RBA will be forced to make a difficult decision.

And with the cost of living expected to be a major issue on the campaign trail, the next rate hikes on the horizon for the first time in 11 years could play a major role in how the contest unfolds.

If market prices during a June rate hike are correct, the next parliament will face the challenge of raising interest rates soon after the next government is sworn in.

How Australians will react to rate hikes for the first time in over a decade, especially after being promised not to raise rates until 2024 not too long ago, is really to guess.

Whichever party wins the next election, it inherits a difficult set of circumstances. Between the prospect of a rapid rate hike, the highest inflation in decades and low levels of consumer confidence, they certainly have their work cut out for them.

Although the RBA may stand on its own as the last holdout, not raising rates longer than the market expected, it will eventually be forced to join its global peers if strong inflationary pressures persist.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommentator

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