After a long series of interest rate hikes, the Reserve Bank of Australia (RBA) has finally paused its cash rate increases. The April 4th announcement has been a relief to many borrowers who were already feeling the pinch of higher mortgage repayments. However, this pause raises the question of what it means for the economy and what the RBA’s strategy is going forward.
To provide some context, the RBA has increased the cash rate by a total of 3.5% over the past year, with the latest increase bringing it to 3.60% from a record low of 0.10%. This is a significant change, particularly for those with variable rate mortgages, who have seen their monthly repayments rise by hundreds, if not thousands of dollars. The RBA’s justification for these increases has been to curb inflation, which had risen to a peak of 8.4% in December 2022, largely due to supply chain disruptions, rising commodity prices and robust employment figures. These are knock-on effects from the double whammy of COVID support measures and rising global tensions, most notably the Russia/Ukraine conflict. Oh, and let’s not forget prior to recent events, over a decade of post GFC loose monetary policy.
Inflation slowing – is it enough?
There are now signs that inflation may be starting to slow down. The latest figures show that inflation fell to 7.4% in January, and then further to 6.8% in February. While this is still well above the RBA’s target rate of 2%, it suggests that the impact of the interest rate hikes is starting to have an effect. Therefore, one possible reason for the pause is to see if this trend continues before deciding whether more interest rate hikes are necessary.
Another reason for the pause could be the fact that many mortgage borrowers are still on fixed rates, which means they have not yet felt the full impact of the interest rate increases. According to some estimates, there are around $380 billion worth of fixed rate mortgages that will absorb all ten rate rises in a single moment when their fixed rate period ends in 2023. The RBA is aware of this and may want to see what the effects of this will be on inflation before making any further decisions.
However, while a pause in interest rate hikes may provide some temporary relief to borrowers, it is important to remember that the RBA’s ultimate goal is to keep inflation under control. The RBA’s target rate is around 2%, which it has not yet reached. Therefore, it is possible that the RBA will resume interest rate hikes in the future if it believes that inflation is still a concern.
Too many jobs?
It’s also worth noting that while the RBA is focused on controlling inflation, there is another economic indicator that is concerning: unemployment. Despite the recent pause in interest rate hikes, unemployment figures remain stubbornly low, which is putting upward pressure on wages and contributing to inflation. While the RBA never explicitly says it, there is an implicit understanding that inflation cannot be totally reigned in with the lowest unemployment figures in decades. In fact, some argue that more people need to lose their jobs to cool the economy and bring inflation under control. However, this is a politically difficult message to convey, and it remains to be seen if the RBA will take more aggressive action to address this issue.
The challenge for the RBA is to reduce inflation without causing a full-blown recession. If the RBA continues to raise interest rates too quickly, it could overshoot the slowdown in economic growth leading to an uncomfortably high rise in unemployment. On the other hand, if it waits too long to act, inflation could spiral out of control, which would have an even more significant impact on the economy.
Ultimately, the RBA’s decision to pause interest rate hikes is a cautious one, and it reflects the delicate balance that the central bank must strike between controlling inflation and maintaining economic growth. It is too early to tell whether this pause will be permanent, or if the RBA will resume interest rate hikes in the future. However, it is clear that inflation remains a concern, and the RBA will continue to monitor the situation closely to ensure that the Australian economy works its way through this tricky period.