Tuesday’s decision to hike interest rates to 3.85 per cent sent shockwaves through the country but Reserve Bank of Australia (RBA) boss Philip Lowe has defended the central bank’s painful move.
The 0.25 per cent increase to interest rates caught many experts by surprise with warnings that the RBA was playing “recession roulette” with Australia’s economy, after most believed the aggressive rate tightening cycle had ended with a pause in April.
The move, which brings the cash rate to its highest level since April 2012 and is the 11th increase in the space of 12 months, had others warning the move was pushing homeowners into financial stress as they are already being battered by the cost of living crisis.
The rate rise will be felt most harshly by the 3.2 million Australian households with a mortgage.
But Dr Lowe defended the bank’s latest move insisting there would be a “worse outlook” for the country if rate rises weren’t pushed through.
He said taming stubborn inflation back to its 2 to 3 per cent target band “within a reasonable time frame” was a big influence on their decision to raise rates again.
“I know that higher interest rates are unwelcome for many people, but the alternative is persistent high inflation and ultimately even higher interest rates and a worse outlook for jobs,” he said at an RBA board dinner in Perth on Tuesday.
Despite data from March showing that inflation had peaked at 7.8 per cent in the December quarter and dropped to 7 per cent in March, it didn’t change the RBA’s view that it would be “some time yet before inflation is back in the target range”, according to Dr Lowe.
He added the decision to pause rate hikes in April was to “provide us with more time to assess the pulse of the economy and the outlook” but since then worrying data had emerged.
This included the low jobless rate, a rise in property prices and persistently high service inflation which includes rents that have recorded their largest rise since March 2010.
“There is a very limited supply of rental properties and rents in Perth have been rising even faster than elsewhere in the country,” he said.
‘Life will become more difficult’
Dr Lowe revealed the central bank was taking longer than other countries to bring down inflation to support employment but it can’t wait “too long”.
“We are taking a bit more time than some other countries, on the basis that doing so can preserve some of the gains in the labour market,” Dr Lowe said.
“But there is a limit here. If we take too long to get inflation back to target, expectations will adjust and life will become more difficult.”
However, he acknowledged that the RBA was “travelling along a narrow path” to tackle inflation while also risking pushing the Australian economy into recession.
But he added that economic data showed there was “some confidence” it could keep the economy on an “even keel”.
Dr Lowe urged Australians “to have confidence that inflation will come down and return to target”.
“If people think inflation is going to remain high then, understandably, they will adjust their behaviour,” he said.
“Firms will be more willing to put up their prices and workers will seek larger pay rises. If this adjustment in expectations were to happen, high inflation would become entrenched and the end result would be even higher interest rates and a poorer outlook for jobs.
“It is for these reasons that the board is resolute in its commitment to returning inflation to target within a reasonable time frame.”
‘Full-blown recession’
But Clifford Bennett, chief economist at ACY Securities, was scathing of the RBA’s decision to hike and has predicted a “full-blown recession for Australia”.
“It is interesting that the RBA acknowledged consumer spending is moderating – there is a slowing – yet chose to still raise rates again?” he said.
“Even though nothing has changed from their previous meeting. Inflation was stubbornly high then.
“There is no doubt this rate hike, with the accompanying commentary suggesting more rate hikes are coming, will take the wind completely out of the sails off the momentary stabilisation in the property market. It will also most certainly tip Australia well into recession.”
Mr Bennett said the inflation issue remains a serious problem and he has forecast a higher end rate nearer 4.5 per cent to 5.5 per cent.
“That looks like where we are now headed. However, given the previous pause, it did appear the RBA had recognised that being so late to recognise rocketing inflation in the first place, there was already significant pain for consumers and businesses from the price increases alone,” he said.
“Therefore, raising rates risked a too severe dampening of activity; one that would precipitate a full-blown recession. Expect Australia to experience that full-blown recession in the second half of this year as the RBA continues to blunder its way forward.”
More rate rises on the horizon
Meanwhile, Dr Lowe said overseas services inflation was “worryingly” and persistently high.
“It is possible that circumstances might be different here in Australia, but the experience abroad points to an upside risk, especially given the high degree of commonality across countries in inflation dynamics recently,” Dr Lowe said.
“Given this flow of data and our assessment of the outlook, the board judged that it was appropriate to increase interest rates again.”
In his post-meeting statement, Dr Lowe also warned more rate rises could be pushed through “but that will depend upon how the economy and inflation evolve”, with the board set to monitor the global economy, trends in household spending and the outlook for inflation.
“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that,” he added.
KPMG chief economist Dr Brendan Rynne believes that interest rates need to increase in order to bring inflation back down to the target band in a more aggressive manner – but thinks another 0.25 per cent hike “will do it”.
“Monetary policy operates with a lag, but given the dynamics in the residential mortgage market it is really working on a two-stage basis at the moment given the number of mortgage holders still enjoying low interest fixed rate mortgages,” he said.
“KPMG’s analysis shows these mortgages taken out during Covid are starting to roll off, but this process will accelerate from the middle of this year.
“So in effect the RBA won’t need to increase rates again as there is an automatic rise in the effective mortgage rate across the country that has a profile consistent with the roll off of fixed rate mortgages. In effect those households that have sheltered from previous rate rises will now feel the full effect of them progressively over the coming year, further enforcing the monetary policy decisions made since May 2022.”
Some experts have also predicted a 0.25 per cent cut to interest rates by August 2024 and a further 0.5 per cent worth of cuts by the end of 2024.