Rate hikes not all doom and gloom, economists suggest

At its monetary policy meeting on Tuesday (2 August) the Reserve Bank of Australia (RBA) board decided to increase the cash rate by 50 bps, taking the cash rate to 1.85 per cent.

The RBA governor Dr Philip Lowe said the central bank was “committed to doing what is necessary” to bring back inflation to its target 2–3 per cent, while keeping the economy on an “even keel”.

It comes as inflation hit 6.1 per cent in the June quarter, with the bank forecasting inflation will peak at 7 ¾ by the end of December.

In justifying another 50-bp hike the RBA noted that inflation is the “highest [it’s] been since the early 1990s” and set to rise further with strong demand and a tight labour market playing a role. In addition the labour market remains tight and businesses are pointing to a lift in wages growth.

While the central bank is on a clear path to bring back inflation, Mr Lowe said it was not on a “pre-set path”, adding: “The path to achieve this balance is a narrow one and clouded in uncertainty, not least because of global developments.”

When making its decision the central bank noted it would be keeping a close eye on the “behaviour of household spending”, given the pressure on budgets with rising inflation and interest rates.

While the cash rate inches towards 2 per cent it remains “well below” the pre-COVID decade average of 2.56 per cent, Corelogic’s research director Tim Lawless said.

Despite this it paints a weaker picture for the housing sector as the cost will likely flow through to variable mortgage holders in a “matter of days” as banks pass on the costs.

“Higher interest rates have already had an immediate downside impact on housing values, with CoreLogic’s combined capital cities index peaking shortly after the first rate on hike in May,” Mr Lawless said.

“Since that time, dwelling values across the combined capital cities index are down -2.8 per cent to 1 August, after rising 25.5 per cent through the recent upswing.”

Nationally, home values are expected to fall 15 per cent over the next 18 months, according to PropTrack’s July report.

Mr Lawless said the trajectory of home value falls will depend on how fast and how high interest rates move, along with the performance of the broader Australian economy, labour markets and demographic trends.

He said lower house prices and higher mortgage repayments may have the RBA’s desired effect and “help to contain inflation” through wealth effects, and limiting household consumption.

Cash rate to remain below 3%: AMP

Despite the doom and gloom, chief economist at AMP, Shane Oliver, has urged borrowers not to “read too much into” what the RBA is saying.

He said while the central bank will do “what is necessary” to rein in the inflation rate, it will likely peak with a “two in front of it rather than a three”.

“We remain of the view that the cash rate won’t have to go as high for the RBA to cool demand enough to take pressure off inflation.”

He explained there was “tentative evidence” that the RBA is getting traction in terms of slowing demand.

In addition, inflation expectations are still contained and many households will experience significant financial stress with rising rates.

Given this, Mr Oliver forecasts the cash rate to peak around 2.6 per cent that is at the “low end of market” and economists’ expectations.

Across the major banks, the Commonwealth Bank has held on its expectations that the cash rate will peak at 2.6 per cent by the end of 2022, which it considers to be “contractionary”.

CBA’s Economic Insights forecasted a 50-bp jump in September, followed by a 25-bp in November, it stated. Unless the Australian Bureau of Statistics wage pressures are “below expectations” (due on 17 August).

“On that basis we would expect three consecutive 25bp rate hikes (ie. September, October, November) to still arrive at the same terminal rate of 2.60 per cent in November,” CBA Insights said.

Prior to RBA’s August announcement, NAB latest expectation was for the RBA to hit 2.6 per cent by February 2023, with Westpac inching towards 3.35 per cent by February 2023 and ANZ coming in strong with its projection at 3.35 per cent by November.

Economic pressure could spark defaults

Given borrowers are most impacted by rising rate environments, CreditorWatch noted the flow-on effect on businesses could spark defaults.

Chief economist at CreditorWatch, Anneke Thompson, said the RBA’s move to raise the cash rate for the fourth month in a row indicates the “level of concern” that inflation is causing.

CreditorWatch’s June probability of default (POD) data, which followed two rate rises at the time, forecasted a 1 percentage point rise in the rate of defaults from small to medium businesses over the next year.

Businesses that are “most reliant” on discretionary spending, such as food and beverage and arts and entertainment, are most at risk.

Those with the highest default probability were within high mortgage rate geographies and where homes were sold in the last few years. For example, Auburn (NSW) and Surfers Paradise in Queensland.

While inflation and rising rates are of concern, Ms Thompson believes that the RBA caught the “cycle earlier” than central banks in other countries.

“It’s important to note that whilst Australia’s inflation number is double the upper range of the RBA’s target, it is far below that of other western nations,” Ms Thompson said.

“Quarterly inflation was also lower than the March quarter (1.8 per cent vs 2.1 per cent in March), which means price rises at least aren’t gaining momentum.”

[Related: RBA announces 4th consecutive rate hike]