In recent weeks, the US Federal Reserve and Bank of Canada joined the ranks of dozens of central banks globally that have raised interest rates in a bid to fight inflation.
In October, the Reserve Bank of New Zealand (RBNZ) took the lead by being the first anglosphere central bank to raise interest rates. It was followed by UK’s Bank of England in December.
Amid this wave of rising interest rates, Australia’s own RBA has been left to belt out its best rendition of Celine Dion’s All By Myself, now that it is the only central bank in the English-speaking world not to raise rates.
Despite inflation sitting well above the RBA’s target band of 2-3 per cent and predictions from economists that it will head significantly higher, RBA Governor Philip Lowe remains reticent to raise rates.
As late as November last year, the RBA remained insistent that the cash rate would remain at its current crisis level of 0.1 per cent. In the months since, it has been forced to revise their commentary. In an address to an Australian Financial Review summit earlier this month, Dr Lowe said: “It is plausible that the cash rate will be increased later this year.”
Earlier this week, Dr Lowe further reiterated the RBA’s reluctance to raise rates, stating that the RBA “will not respond until there is evidence of pervasive price pressures”.
Meanwhile in the world of bonds and interest rate futures markets, a very different picture of the future of the cash rate is being priced in.
According to the ASX’s Cash Rate Futures, a rate hike is very nearly priced in for June, with an additional four expected by the end of the year. On a longer-term time horizon, the cash rate is expected to sit at 2.79 per cent in August next year.
A uniquely Australian challenge
With Australians holding the second highest level of household debt in the world at 119.3 per cent of GDP, the impact of rising rates would be felt much more strongly in Australia than in most of the developed world.
When AMP Capital’s chief economist Shane Oliver spoke to the Sydney Morning Herald in November, he warned that the large amount of debt held by Australians meant the RBA could only incrementally raise rates.
“If the Reserve Bank increased interest rates by 100 basis points in a year, it would drive the country back into recession,” Dr Oliver said.
In the US, prior to the housing crash that played a major role in triggering the global financial crisis in 2008, household debt peaked at almost 101 per cent of GDP. But unlike Australia where the majority of loans have variable interest rates, the vast majority of loans even at the peak of the US housing bubble were fixed on 15 to 30-year terms.
Despite a relatively low proportion of Americans holding variable rate loans, a combination of rising rates and tightening credit was enough to send the US housing market plummeting.
For this reason among others, the RBA is arguably likely to remain reticent to raise rates for as long as it reasonably can.
Falling behind the anglosphere
In the coming months, central banks throughout the world are expected to continue to raise interest rates. In the US, markets are currently pricing in a 65 per cent chance that the Federal Reserve will raise rates by a full 1 per cent across their next two meetings.
With markets currently not expecting the RBA to raise rates in the next few months, Australia could be 1 per cent or more behind the US by the time the RBA feels sufficiently comfortable in raising rates.
Under more normal circumstances this rate differential could put downward pressure on the Australian dollar and add to inflationary pressures. But with the war in Ukraine and other factors currently supporting higher commodity prices, the RBA may have more scope to keep rates on hold for longer.
Elections and a challenging start for the next parliament
While a rate rise before the upcoming federal election is not currently considered likely, if inflation data continues to surprise, it’s entirely possible the RBA could be forced to make a tough decision.
And with the cost of living expected to be a major issue in the election campaign, upcoming rate hikes on the horizon for the first time in 11 years may play a major role in dictating how the contest unfolds.
If markets pricing in a June rate hike are correct, the next parliament will face the challenge of rising interest rates shortly after the next government is sworn in.
How Australians will react to rising rates for the first time in more than a decade, especially after being promised no rate hikes until 2024 not long ago, is really anyone’s guess.
For whichever party wins the next election, they inherit a challenging set of circumstances. Between the prospect of rapidly rising rates, the highest inflation in decades and poor levels of consumer sentiment, they certainly have their work cut out for them.
While the RBA may remain all by itself as the last remaining holdout, not raising rates for longer than the market expects, eventually it will be forced to join its global peers if strong inflationary pressures persist.