RBA Raises Interest Rates For The First Time in a Decade

Right in the middle of an election campaign, the Reserve Bank of Australia (RBA) has raised interest rates for the first time in 11 years in its first intervention in a federal election since the Howard coalition government lost office in late 2007.

From the first in what will be a series of hikes, the RBA board raised the official cash rate by 25 basis points to 0.35 per cent, from a record low of 0.1 per cent. The RBA governor Phil Lowe said, “the official interest rate could reach a more normal level of 2.5 per cent before the bank stops lifting rates.”

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The board thinks now is the right time to begin withdrawing some of the extraordinary monetary support that was provided during the pandemic to stabilize the Australian economy.

The economy has proven to be resilient and inflation has picked up more quickly to a higher level than expected and the wage growth is also picking up. Given this, and the very low level of interest rates, the board thinks it’s appropriate to start the process of normalising monetary conditions.

With Tuesday's move, this is the first time in 11 years that more than one million home borrowers will experience an increase in mortgage rates.

The effect of RBA’s sudden interest rate hike

PropTrack economist Paul Ryan said, “the RBA acted following stronger-than-expected inflation and a pickup in inflation expectations”.

Mr Ryan added, "By moving today rather than waiting for further data in June, the RBA is signalling that it will intervene to curb stronger-than-expected inflationary pressures, despite the ongoing federal election campaign".

Although the RBA seeks to remain independent from politics, these changes may be viewed as a greater political intervention. In any case, the rising cost of living has been a key issue in the election campaign ahead of the May 22 poll.

The last time the RBA lifted rates during an election campaign was in November 2007, a couple of weeks before the Howard coalition government lost office.

A surge in inflation brought forward the first hike

A month ago the RBA indicated that it wanted additional evidence on both inflation and labour costs before lifting rates and the surge in inflation led to the pre-election rate rise.

The inflation indicated strong domestic demand and prove to be both stronger and broader than the RBA expected. The measures for inflation expectations and significant reporting of inflationary pressures have also increased.

Since the RBA's internal indicators of wage growth have picked up, it is expected that the official indicators of wage growth will also increase.

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Several rate hikes are on the way 

With Tuesday's first hike, RBA signalled what will be a series of rate rises, with several increases expected this year. The key question is the key question being how high and fast rates rise.

Since 2021, the housing price growth has already slowed in anticipation of higher borrowing costs, especially in capital cities like Melbourne and Sydney. This move will weigh further on the housing price growth and slow it down even more. 

Mr Ryan mentioned, “the outlook for housing prices later in the year is one of a balance between higher mortgage rates and the higher income growth the RBA is looking to see before raising rates.”

While the RBA is planning a number of hikes, its decision making will be influenced by the flow of economic data. They will allow people to adjust slowly while they slow down their spending to be able to assess the effect of monetary policy changes on the economy.

Predictions for interest rate hikes

RBA governor Phil Lowe said, “Over the time, it’s not unreasonable to expect interest rates would get to 2.5 per cent. How quickly we get there, and if we do get there will be determined by how events unfold”.

Economists are predicting numerous rate hikes but differ on the number of increases, timing and the level of the peak in the cash rate.

The economists of the Commonwealth Bank of Australia predict the cash rate will be at 1% by the end of 2022, while the National Australia Bank says 1.25% and both Westpac and ANZ forecast 1.5% by year-end.

CBA expects the cash rate to reach 1.25% in early 2023, Westpac has a peak of 2% by May 2023 and NAB sees it reaching about 2.5% in 2024. ANZ expects a cash rate of 2.25% by May 2023, which is likely to go beyond 3% in time.

The cost of an interest rate hike

When the interest rates hike many households with mortgages will see their loan repayments follow. With Tuesday’s decision, the lenders are expected to pass on a 25 basis points increase in full so how much would that actually cost? 

It actually depends on how much you owe, the type of loan you have and your current interest rate. If you have borrowed a $500,000 home loan, your monthly repayments will rise by $65 and for someone with a $1 million loan, the monthly repayments will rise by $130.

The advice here is to start building an additional financial buffer and consider whether the current home loan is the best you can do. 

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