Australian borrowers let out a collective groan on Tuesday afternoon, thanks to the Reserve Bank’s decision to push up interest rates by a quarter of a percentage point. The sweet relief of the rate-cutting cycle was short-lived.
The Reserve Bank’s decision to push up rates was ultimately the path of least regret.
A month ago, the decision on whether to hold or raise rates was a coin toss, but over the past four weeks in particular, a deluge of economic data tipped the scales.
The evidence is now solid enough that the economy is running too hot – thanks to household spending, investment and housing – and inflation has kicked up enough to furrow the brows of our central bank’s board.
Sure, there were cogent arguments in favour of the central bank waiting until late March to get a clearer picture of the economy – particularly whether the inflation that’s now showing up is transitory.
Those economists who support a less trigger-happy central bank suggest it should adopt a wait-and-see approach to interest rates and argue that the stronger Australian dollar, which acts as a brake on the economy, mitigates the need to move pre-emptively on rates.
But sitting on the fence comes with risks.
If the Reserve Bank did nothing and inflation gathered a head of steam, the measures needed to bring it down would be more painful for borrowers. Over time, it could result in more or larger rate increases.
So raising rates by a quarter of a percentage point could just as readily be described as the path of least pain. Ultimately, it could turn out to be the Goldilocks move.
However, if the Reserve Bank moves to increase rates again in the first half of this year – which many economists see as a distinct possibility – the hit to household balance sheets will be felt more acutely.
(A quarter of a percentage point rise in rates will cost a borrower with a $750,000 mortgage about $120 extra a month.)
Clearly a rate hike polarises depositors and borrowers. It is helpful to the often older and more affluent cohort with money in the bank who will earn additional income on their deposits.
But even among those with a mortgage, there is a big divide between those struggling to pay their monthly interest and a larger group – more than 80 per cent – who didn’t adjust their payments when rates were falling and instead have built a buffer in their mortgage offset account.
That is the real reason the banks showed no marked increase in mortgage arrears when rates were going up.
Unfortunately, there is a smaller rump of borrowers who are struggling to meet monthly interest bills. These are in the group feeling the real pain of the cost of living and will find their finances even more difficult to navigate now the government support package for energy bills has rolled off.
For the big Australian banks – all of which predicted this latest rise – it is expected to be a net positive for their earnings. This is despite the risk that higher rates could negatively impact the volume of loan growth.
Meanwhile, a rate rise will either earn Australia the title of “first mover” among the world’s developed countries or make it a global pariah. This will inevitably lead to criticisms that our central bank didn’t do enough to smother inflation when it was spiralling upwards in 2022, after the government’s massive COVID stimulus.
The RBA lifted its cash rate by 425 basis points between May 2022 and November 2023 – less tightening than many other central banks delivered at the time.
This meant that growth slowed by less than elsewhere, the unemployment rate only rose a little bit and inflation came down slowly. It gave Australian borrowers some degree of anaesthesia for household balance-sheet pain.
Sure, Australia got the soft landing the Reserve Bank had been navigating, but what about the bump at the end of the tarmac?
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