Interest rates have been a hot topic around the world ever since inflation took a stranglehold on the west. Even though inflation is falling in the US and to a lesser extent, the EU, there have been no signs of falling interest rates yet. For Australia, BoA interest rates are already lower than those two regions, but inflation remains higher at 6%.
Many pundits believed raising interest rates to as high as they have been was the wrong remedy. However, central banks are autonomous from the government, and so it may be a case of unwillingly taking matters into their own hands if they feel the government is not doing enough.
Michele Bullock, an RBA governor, recently claimed that higher mortgage rates were already working to slow down the economy. On the one hand, Australia’s low unemployment rate does indicate that the economy is, and was, cooking on high.
On the other hand, collapsing exports to China and supply side shocks in energy is not usually a mandate for contractionary monetary policy. But again, this may be a matter of the RBA using the only tool it can, because the government has not shown to take control of the situation. For this reason, we may not see interest rates drop until inflation significantly falls.
Have rates been rumored to drop soon?
Interest rates have not been seriously rumored to drop any time soon. In fact, earlier this week the RBA’s minutes from the 3rd of October meeting were released. In them showed a board weighing up a potential 25 base point increase.
The minutes said, “There had not been sufficient new information over the preceding month from economic data or financial markets to necessitate [an increase]”. Regarding the next meeting on the 7th of November, it was said that “Some further tightening of policy may be required should inflation prove more persistent than expected.”
With a recent 0.40% GDP growth figure, policymakers will be concerned with the possibility of stagnation, if not contraction. However, inflation is clearly the priority, and the minutes from the meeting suggested that the RBA are concerned that inflation is not slowing as expected.
How and when will inflation fall?
Clearly, the answer to how long interest rates will remain high is closely tied to how long the issue of high inflation will persist. This week, it was a rise in petrol prices that prevented the UK’s inflation from falling, which were caused by deepened tensions in the Middle East since Hamas’s attack, along with production cuts from Russia and Saudi Arabia.
The RBA has misjudged how long it will take for inflation to fall because it’s inherently difficult to forecast—there are many metrics in the basket, not to mention constantly developing geopolitical events. US and EU cooling inflation will give Australia confidence, but some inflation causes are unique to Australia.
However, more pressure is being put on the government, particularly as recent analysis shows that a profit spiral has been a big factor. The thinktank believes that business earnings from big firms accounts for 69% of the surplus inflation (the portion of inflation above the target rate).
How long does a change in interest rate have a wide-spread effect?
Another reason for Australia’s persistent inflation is because interest rates do not have an immediate effect; it’s lagged. This is because it takes a while for bond issuers, lenders, and banks to adjust all of their rates and subsequently have an effect. For example, many Australians have a 2 or 3-year term on their current mortgage. This is more similar to Britain here, unlike the US who tend to have multi-decade fixed terms.
A shorter term means that many people will have had to remortgage during this past year, which then increases their fixed rate and thus repayments. As RBA pointed out, mortgage repayments have begun to take effect. So, with falling real wages (wages increases are lower than inflation), increased outgoings, and decreasing household debt, it seems that Australians are spending less.
Except, they’re not. Australians are still spending confidently, which isn’t helping inflation, and are somewhat making up for their declining exports. Disposable income is down, personal savings are down, but consumer confidence is up.
Markets are shaped by people
While deterministic economic systems have lagged effects, there’s one thing that reacts instantly, which is markets. Traders, investors, businesses, and consumers all have their own opinions, which react to the news they see each day.
Economic activity, and therefore inflation, is at the mercy of this collective behavior. As we can see, on paper, Australians should certainly be less confident right now in theory, and therefore spending less.
The truth is that confidence is only up relatively speaking. The highest in six months isn’t saying much, given the world has endured a global pandemic, followed by various wars. But it is still the resilience of Australia’s spending, strong labor market, and low levels of debt in the face of adversity that continues to keep the economy afloat—just as it did in 2008. But, it isn’t conducive to reducing inflation.
The question that it now begs is that, just how much are the higher interest rates affecting Australians given all of this? Relative to many other major economics, Australian real estate is booming. It may be that having lower rates than the US, UK, EU, and Canada means that the heightened rates may have to stick around longer than theirs.
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Interest rates in Australia are not expected to drop soon, with the RBA considering a rate increase of 25 basis points due to ongoing high inflation & economic conditions. 😟💼📈 #TheIndianSun #Inflationhttps://t.co/gkgL3OXB93
— The Indian Sun (@The_Indian_Sun) October 23, 2023