Interest rates lifted to highest level in 15 years

Mortgagees have again been left carrying the can for an overheated economy, with the official cash rate on Tuesday (29 September) lifted to its highest rate since 2011.

The Reserve Bank of Australia (RBA) decision to lift interest rates by another 25 basis points to 4.60 per cent will add $114 per month to the average $700,000 loan.

Inflation continues to track beyond the RBA’s preferred 2-3 per cent range, forcing it to wield the only tool at its disposal for the fourth time this year.

While household spending across the entire country is elevated, it’s borrowers who are forced to do the heavy lifting in trying to tame inflation.

Given the largest contributors to inflation are housing and fuel, it’s difficult to imagine the rate hikes will do anything to suppress inflation or deter subsequent  rate hikes.

Housing spending only rises as rate hikes are passed on to renters and fuel is a necessity that has its inflationary source in a Middle East conflict that won’t be placated by higher rates in Australia.

So, Australians with a mortgage or loan can expect more rate hikes in November and early 2027.

Upside risks the RBA has been warning about are now materialising. 

The economy has slowed, but not enough to give the RBA confidence that inflation will return sustainably to target without further tightening. Unemployment has lifted, but the labour market remains relatively resilient.

Household spending data released Tuesday was unchanged in August but was 6.8 per cent higher than the same time last year. Weak productivity growth means the economy has less capacity to absorb demand without generating inflationary pressure.

The RBA’s Monetary Policy Decision noted that there continues to be heightened uncertainties about the outlook for domestic economic activity and inflation.

“The Middle East conflict remains unresolved, and there are scenarios where inflation is higher and activity lower than forecast.

“Global oil supply disruptions are maintaining upward pressure on global and domestic energy prices and inflation.

“A period of prolonged uncertainty may also cause growth to be lower overseas and in Australia (but) to date, however, growth in Australia’s major trading partners has been stronger than expected, as the boost from AI-related investment has outweighed the adverse effects of the Middle East conflict.

In Australia, weak productivity growth continues to constrain potential growth and there are uncertainties about the economic effects of the downturn in the housing market.”

Property prices impacted

Falling property prices will also be exacerbated by the current rate hiking cycle.

Eleanor Creagh, realestate.com.au’s Senior Economist, said another rate rise reinforces the downturn already underway.

“Higher mortgage rates further reduce borrowing capacities and buyer budgets, adding to the downward pressure on home prices and sales activity.

“However, this remains an orderly adjustment rather than a distressed housing correction. Labour market conditions remain relatively resilient, very few borrowers are in negative equity while many households retain substantial repayment buffers.

“The RBA does not target home prices, and the current housing slowdown is one of the channels through which tighter monetary policy is working to reduce demand.

“While structural housing undersupply remains a long-term support for prices, in the near-term, affordability constraints, higher borrowing costs and weaker buyer demand are likely to keep downward pressure on prices.”

Global economic comparisons

Interest rates are rising around the world but Australia is outpacing most of its peers.

Among OECD member countries, only Turkey and Mexico currently maintain higher benchmark central bank interest rates than Australia.

The others, including the United States (4.00 per cent), the United Kingdom (3.75 per cent), the Euro Area (2.65 per cent), and Canada (2.25 per cent), currently have lower benchmark interest rates than Australia.

The OECD has warned that the economic fallout from the Middle East war initiated during US President Donald Trump’s term is likely to persist into the second half of his presidency.

“Our main message is that central banks have to remain very vigilant,” OECD chief economist Stefano Scarpetta said.

“They need to intervene like they have done so far, perhaps more than what they did in 2022.”

The OECD’s assessment follows a fresh round of monetary tightening, with the US Federal Reserve, European Central Bank and Bank of Japan all raising interest rates within little more than a week of one another.

Could rates tumble quickly?

While markets were prepared for the latest RBA rate rise, the global economy could still deliver a very different interest-rate environment over the next 12 to 18 months.

One of the clearest catalysts would be a sharp US economic slowdown. If unemployment rose rapidly and consumer demand weakened, the US Federal Reserve could respond with substantial rate cuts or renewed quantitative easing. Lower US bond yields would flow through global financial markets and could help reduce borrowing costs in Australia.

A major Chinese slowdown could have the opposite impact initially, but ultimately create conditions for lower Australian rates. Weaker Chinese construction and manufacturing would reduce demand for iron ore and other Australian commodities, potentially weakening export income, business investment and domestic economic growth. The inflationary impact would depend partly on what happened to the Australian dollar.

Falling global oil prices could provide an even more direct disinflationary shock. The current Middle East conflict has pushed energy prices higher and become an important inflation risk for central banks. A de-escalation, increased supply or a sharp deterioration in global demand could reverse that pressure quickly.

A significant slowdown for another major trading partner, Japan, that was followed by renewed monetary stimulus could push global bond yields lower and alter international capital flows, although the effect on Australia would depend on the broader global response.

A global credit shock is a more damaging route to lower rates. A banking, property or corporate-debt crisis could force central banks to cut aggressively as demand collapsed.

For Australia, the prospects of a rapid rate reversal are not simply tied to whether overseas central banks cut rates. Global developments would need to feed through into weaker domestic inflation, softer demand or lower financial-market costs before the RBA could move rapidly in that direction.

Nathan Birch, founder of B.Invested, predicted a major international rupture was on the cards and beyond the control of local politicians.

He specified developments in major international economies, particularly in the U.S and Japan, as having implications for borrowing costs and financial markets around the world.

“US 10-year Treasury bonds yields hit 5.2 per cent recently while Japan sustained a zero percent interest rates for a long time, but this is rising sharply now and is an indication that a global financial depression is well upon us.”

He added that currently, the US government is $40 trillion in debt and has to print its own money, which is devaluing its currency, increasing the price of bonds, and fuelling a potentially significant crack in the financial system.

As an investor, he said he is not worried about the impending rates.

“I expect to see further panic-selling during this time, so investors seeking cash flow positive assets will have increased opportunities to purchase if they do so strategically and with sufficient cash flow and borrowing capacity. 

“The opportunity for investors is in the fear,” he said.

He also warned that if central banks are ultimately forced to cut rates aggressively in response to a major economic downturn, the resulting increase in liquidity could once again fuel asset-price inflation.

“We’re not seeing property simply collapse everywhere because rates are higher. Some markets and properties may soften, but inflation is still running through the global economy,” he said. 

“Don’t buy something just because you think rates are going down, and don’t sell a good asset simply because rates have gone up.”