(Credit: Michelle Bowes & Johanna Leggatt – Forbes)
Australians were hit with a surprise last year when interest rates started to rise at a much faster pace than anticipated. After starting the year at just 0.1%, the official cash rate has now reached 3.1% and is tipped to rise further. Since the Reserve Bank of Australia (RBA) began lifting the cash rate in May 2022, there have been eight interest rate rises last year, totaling a combined 3%.
The rises have come despite the RBA governor, Dr. Philip Lowe, giving guidance during the Covid-19 pandemic that official interest rates were unlikely to rise until 2024. Based on this, and coupled with an extended period of record low interest rates, many Australians borrowed heavily, taking on large mortgages to meet soaring house prices. As a result, many may now be starting to experience mortgage stress, especially as a large number are expected to come off fixed-rate mortgages this year and roll onto the higher variable rate.
ForbesAdvisor asked three top economists why rates began rising earlier than expected, whether they will continue to rise, what will stop the increases, and when they might start to fall.
Why Are Interest Rates Rising?
Nicki Hutley, an independent economist and economic consultant, Alexis Gray, senior economist for Asia Pacific at Vanguard, and Sarah Hunter, senior economist and partner at KPMG, all agree that the RBA is increasing interest rates to quell rising inflation.
As Gray explains, three key factors are contributing to rising inflation:
Pent-up demand as consumers spend what they saved during Covid-19.
A change in spending habits with an increased appetite for physical goods that suppliers are struggling to meet.
The Ukraine-Russia conflict, which has affected the production of many goods as well as supply chains due to constrained oil and gas supplies.
Of these, Hunter says it is the first two that the RBA is particularly concerned with. “Effectively, we’ve got a mismatch between domestic demand and supply capacity and that generates inflationary pressures,” she says.
Gray says that both the headline and core rate of inflation were already over 6%, which is well above the RBA’s 2% to 3% target range for keeping supply and demand in equilibrium.
The reason interest rate increases are such an effective tool in bringing inflation down is that they affect most Australians. “Interest rates affect every loan across the economy, whether it’s a mortgage or a business loan. Higher rates make it more expensive to service your loan, and therefore cause you to cut back in other areas,” Gray says. She adds that even for those without debts, rising interest rates send a signal to become more cautious about spending money.
Last year’s interest rate rises have felt like a shock because interest rates have been so low for so long. The last time the RBA increased interest rates was in 2010, and the last time interest rates rose this quickly in such a short period of time was in 1994.
“It’s important to remember that rates were at historical lows and once the economy was shown to be relatively robust after Covid-19, there was always going to be a normalization of rates. The big question was how far and how fast, rather than whether rates were going to rise,” Hutley says.
Will They Continue to Rise?
All three economists agreed that the rises would continue. They were right in their predictions that the RBA would increase rates on both its November 1 and December 6 board meetings.
Hunter accurately forecast another two rises of 25 basis points for 2022, to end the year at 3.1%.
As to where it goes from there, Gray says the cash rate will eventually reach 3.5% to 4% over the next several months.
Most recently, Deutsche Bank Australia senior economist Phil
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