Most aggressive interest rate moves in 28 years

• The Reserve Bank (RBA) Board has lifted the cash rate by 50 basis points (half of a percent) for an unprecedented third straight month, taking the cash rate to 1.85 per cent – the highest level since April 2016. This also represents the most aggressive monetary policy action since 1994. The RBA increased the interest rate on Exchange Settlement balances by 50 basis points to 1.75 per cent.
• The Board said that it “expects to take further steps in the process of normalising monetary conditions over the months ahead, but it is not on a pre-set path.” This is an important addition to the final paragraph of the statement to indicate that future rate hikes could be either smaller or larger depending how data evolves.

What does it all mean?

• The Reserve Bank has lifted rates for an unprecedented fourth month in a row with the cash rate now at the highest level in over six years. Whether you call the moves a ‘removal of stimulus’ or a ‘tightening’ of monetary policy, the intention is the same – to slow down the pace of spending or demand at a time when supply (production) is constrained at home and abroad. The aim being to achieve a better balance between supply and demand, thus restraining inflationary pressures.
• The $64 question is at what point do interest rate settings become restrictive? The Reserve Bank Governor is working on the assumption that the neutral cash rate is 2.5 per cent – the interest rate level that is neither slowing down the economy from its long-term average pace of growth nor speeding it up. But how correct is that 2.5 per cent assumption? The cash rate was last at that level 7½ years ago. And the cash rate was just 0.75 per cent before the pandemic broke in early 2020.
• Commonwealth Bank (CBA) Group economists expect the cash rate to rise further in coming months: another 50bp move is expected in September and a 25bp move in November, taking the cash rate to 2.60 per cent by year-end.
• The RBA has tried to muddy the waters on future moves by indicating that it wasn’t on a designated flight path. If there was any time that the Reserve Bank should be stepping up its business liaison efforts, it is now. The risk is that rates could be lifted too far, too fast and result in a major check to economic momentum.
• In terms of new forecasts: “The Bank’s central forecast is for CPI inflation to be around 7¾ per cent over 2022, a little above 4 per cent over 2023 and around 3 per cent over 2024.” And “The Bank’s central forecast is for GDP growth of 3¼ per cent over 2022 and 1¾ per cent in each of the following two years.”
• Commonwealth Bank (CBA) Group economists still expect the Australian economy to slow, rather than stall. In calendar 2022 the economy is tipped to grow by 3.5 per cent and then grow a further 2.1 per cent in calendar 2023.

• The Reserve Bank has sought to stress the solid fundamentals on the economy, noting that, “The Australian economy is expected to continue to grow strongly this year” and noting, “Employment is growing strongly, consumer spending has been resilient and an upswing in business investment is underway.”
• On wage pressures, the Reserve Bank said: “Our liaison program and business surveys continue to point to a lift in wages growth from the low rates of recent years as firms compete for staff in the tight labour market.” 

• The RBA lifted the cash rate by 50 basis points (bp) or half a per cent to 1.85 per cent. This follows 50bp rate increases in June and July and a 25bp increase on May 3, 2022. The RBA last cut the cash rate from 0.25 per cent to 0.10 per cent on November 3, 2020. Before the Covid-19 health and economic crisis, the official cash rate was 0.75 per cent on February 5, 2020.

• Overall, the Reserve Bank (RBA) has no alternative but to lift rates to a more neutral (less stimulatory) setting. The RBA thinks this is a cash rate near 2.5 per cent. Commonwealth Bank (CBA) Group economists expect 50 basis point hikes to be delivered in August and September and a 25 basis point move later in 2022. We expect that a cash rate of 2.6 per cent will be successful in getting inflation under control to the extent where interest rate cuts will be contemplated later in 2023.
•  The annual headline rate of inflation is unlikely to peak until the December quarter 2022 at 6¾ per cent, so the Reserve Bank must remain vigilant for some time yet.

Implications

• ·The housing market has quickly responded to higher interest rates. In fact, since rates started to rise, Sydney prices have slowed by the most in 40 years. Outright falls in home prices will become common across the country in the next few months.
• The ‘normalisation’ or interest rates remains an incredibly positive development for savers. Household deposits have risen 30 per cent or $286 billion since Covid hit in February 2022. If the 50bp rate is fully passed on, it will add more than $6.4 billion to household incomes – providing a welcome boost especially to the incomes of retirees.

Originally published by CommSec