RBA opts for 50-bp cash rate hike

On Tuesday (7 June), the Reserve Bank of Australia (RBA) decided to increase the cash rate by 50 bps, from 0.35 per cent to 0.85 per cent.

The move marks the largest increase to the rate in 22 years, since the RBA raised by 50 bps in February 2000.

It follows the bank's 25-bp increase in May, when the RBA lifted the rate for the first time in more than a decade, up from its historic low of 0.1 per cent.

While economists had been certain a rise was on the cards, most had assumed the RBA would either choose from a 25-bp or 40-bp increase, after the central bank deliberated between the two options in May.

But as RBA governor Philip Lowe has explained in his monetary policy decision statement, the board had decided to take a larger step, amid high inflation pressures and the “still very low level of interest rates”.

He has also flagged additional rises for the months ahead.

“The board expects to take further steps in the process of normalizing monetary conditions in Australia over the months ahead,” Dr Lowe wrote.

“The size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market.

“The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

In recent years, the RBA has aimed for a target annual inflation range of 2-3 per cent. But inflation overshot the target for the year to March, surging to 5.1 per cent.

Dr Lowe’s statement noted that inflation has “increased significantly” and is at a higher level earlier than expected, amid COVID-related disruptions to global supply chains, the Ukraine war, uncertainties around China, a tight domestic labour market and capacity constraints in some sectors.

He also pointed to the floods across NSW and Queensland.

But prices aren’t expected to stop ballooning anytime soon.

“Inflation is expected to increase further, but then decline back towards the 2-3 per cent range next year. Higher prices for [electricity] and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago,” Dr Lowe noted.

“As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate.”

The June cash rate incline is expected to help return the inflation rate down to target over time.

Dr Lowe stated the Australian economy has remained resilient, while the RBA’s business liaison program has pointed to a lift in wages growth.

Unemployment is also sitting at 3.9 per cent, the lowest in almost 50 years.

However, there will be growing pressure for households’ budgets, with Dr Lowe insisting the board will keep a close eye on consumers.

“Housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic, supporting household wealth and spending,” he stated.

“The household saving rate also remains higher than it was before the pandemic and many households have built up large financial buffers.

“While the central scenario is for strong household consumption growth this year, the Board will be paying close attention to these various influences on consumption as it assesses the appropriate setting of monetary policy.”

CoreLogic has estimated that the banks will soon pass on the 50-bp hike, which would take the average variable interest rate for a new owner-occupier loan to around 3.16 per cent.

Together with the 25-bp increase handed down in May, the cumulative 75-bp increase will add around $200 per month in additional repayments on a $500,000 mortgage, compared with home loan rates in April.

CoreLogic research director Tim Lawless also noted the escalated costs of living.

“In a double whammy for indebted households, the additional cost of debt comes as non-discretionary inflation rises at more than twice the pace of prices for discretionary goods,” he wrote.

“Higher costs for food, fuel and finance are likely to see household savings continue to taper as families funnel more of their income towards servicing their mortgage and funding essential costs of living.”

Similarly, Paul Ryan, economist with PropTrack noted that expectations of higher rates have already weighed on the housing market.

Financial markets have priced in a cash rate 2 percentage points higher by the end of 2022, which would raise mortgage repayments by another 24 per cent, Mr Ryan calculated.

However, economists from the major banks have predicted the RBA will opt for more conservative moves.

“Housing price growth has slowed significantly, with annual price growth falling from 24 per cent six months ago to only 14 per cent in the year to May,” Mr Ryan said.

“This slowdown has particularly affected the most expensive capital markets of Sydney, Melbourne and the ACT, which recorded price falls in May.”

Settled sales estimates from CoreLogic have indicated that dwelling sales over the three months to the end of May were down by 19 per cent year-on-year.

Mr Lawless expects that the downturn in Sydney and Melbourne will eventually spread to other regions, but the trajectory will depend on “how fast and how interest rates move and normalise”, along with how the broader economy and labour market perform.

“A combination of higher fixed mortgage rates, lower consumer sentiment, tighter credit conditions and worsening affordability have all played a role in the slowdown to-date,” he stated.