What would it take for interest rates to rise?
What would it take for interest rates to rise?
With the Australian cash rate at a record low of 0.1%, many of us may be worried an interest rate hike is just around the corner. While an eventual cash rate rise is inevitable, several things would need to occur for an increase to be announced in the near future.
To understand how this would work, let’s start by looking at how cash rate movements occur and why.
Why does the RBA increase or decrease the cash rate?
The cash rate is the interest rate that the Reserve Bank of Australia (RBA) charges banks for loans. While banks establish their own interest rates for customers, generally those rates will be derived from the cash rate.
Changes to the cash rate target are used as a lever in monetary policy to encourage or discourage spending. This has a direct impact on the economy. When interest rates are lower it encourages people to borrow money and consumers to spend rather than save. This causes the economy to grow, keeps unemployment low and causes inflation to increase.
The RBA has indicated they don’t believe the economy will require tighter monetary policy until at least 2024. So, what would need to occur to necessitate a cash rate rise before then?
Wage growth and unemployment
Wage growth is a necessary factor to encourage consumer spending. Even with record low interest rates, without wage growth consumers simply can’t increase their spending, which hampers the ability of the economy to grow.
The only way for wages to grow is for the labour market to be tight enough for demand for labour to outstrip supply. That means that unemployment needs to be low enough for there to be a shortage of labour. When there are more jobs than available talent, employers need to offer more attractive remuneration to attract candidates. When this occurs across the board, this encourages wage growth.
The RBA has suggested that unemployment would need to be around 4 per cent to achieve their target wage growth of 3 per cent. That would help inflation rise to their target of 2-3 per cent. They’re anticipating this won’t occur until at least 2024. Given wage growth hasn’t reached 3 per cent since 2012, it’s very unlikely that we’ll see that kind of wage growth before then, especially off the back of the pandemic and with government stimulus like JobKeeper drawing to a close.
While the economy is recovering well, it’s unlikely things will recover to the desired level before 2024. Unemployment is currently at 5.8 per cent and job vacancies have grown by 13.7 per cent since November 2020 to nearly 290,000 vacancies. While this is promising, wage growth is still at a historic low of 1.4 per cent. It has a long way to go before hitting the RBA’s target.
Housing market boom
One area that is surging at the moment is the housing market. Low interest rates have fuelled demand for housing which has pushed up prices in many property markets. With borrowers taking on more and more debt, a sudden sharp increase in mortgage rates could lead to severe mortgage stress for many homeowners and have negative impact on the property market.
Amid fears about housing affordability and mortgage stress, one option the RBA has at their disposal to rein in the housing boom is to increase the cash rate. This would make borrowing costs more expensive which would serve as a disincentive to homebuyers and property investors, reducing demand and stabilising property prices.
Some economists are predicting the housing boom could bring forward a cash rate hike by a year or two. Others aren’t so sure. AMP Capital chief economist Shane Oliver has suggested it could happen, but only if the rest of the economy recovers quickly. A far more likely scenario is the introduction of tighter lending practices and a reduction in government incentives such as the First Home Loan Deposit Scheme and HomeBuilder to reduce demand in the housing market.
The global economy has a direct impact on the Australian economy. The RBA pays close attention to what is going on overseas before making cash rate decisions.
In Bloomberg’s quarterly review of monetary policy, no major western central bank is expected to hike interest rates this year. In fact, China, India, Russia and Mexico are among those predicted to cut their rates further. The trend globally is for loose or expansionary monetary policy which has led to low interest rates across the board.
Other considerations the RBA makes when it comes to the international economy is demand for Australian products and services, the value of the Australian dollar and any tensions with major trade partners such as China. Until the global economy has recovered further from the pandemic, it’s unlikely we’ll see any international conditions which see the RBA wanting to increase the Australian cash rate. An increase in the Australian cash rate could make our exports less attractive and have an impact on overseas investment in Australian products.
Ultimately, we feel a number of circumstances for the Australian economy, housing market and global economy would need to occur simultaneously in order to drive a significant cash rate rise before 2024. What is far more likely is that the cash rate will remain closer to 0.1% for the next few years. That doesn’t mean that your interest rate won’t rise however. Remember that banks determine their own interest rates, so it’s important to keep a close eye on what you’re paying to ensure you’re getting the best deal.
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