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Prepared for rising interest rates?

Prepared for rising interest rates?
Prepared for rising interest rates?
Far from the top. Over the past few months, we’ve seen sharp increases in the RBA cash rate target. On August 2, the RBA – as expected – increased the cash target rate to 1.85%. While we would like to say this is the top, the reality is we’re far from it. Market consensus expectations are for the target rate to increase to 3.35% during 2023, which will result in home loan interest rates of 4.98%.

Cash Rates, Inflation, Wages Growth and Asset Pricing

  • At the RBA Monetary Policy Decision meeting on August 2, 2022, the RBA decided to increase the cash rate target by 50 basis points to 1.85%. This was consistent with the forecasts and commentary in the RBA’s previous meetings. Money market activity is also decreasing and the RBA has a desire to reduce its AUD investments from the current unprecedented, historical highs.
  • While debate rages about the cause of the latest inflation figure of 6.1%, without federal and state authorities reducing infrastructure and social spending or changes in global trade, the only tool available to the RBA to reduce inflation to the target 2-3% is quantitative tightening.

Exhibit 1: GDP, Inflation and RBA Cash Rate

Line chart showing the RBA Cash Rate, GDP, and Inflation from 1990 to 2021. The Cash Rate declines from 12.50% to near zero by 2020, GDP fluctuates with a sharp dip in 2020, and Inflation shows moderate fluctuations with a notable dip and recovery in 2020.

Exhibit 2: Wage Growth and Unemployment

Line chart showing Wage Price Growth and the Unemployment Rate from 1998 to 2020. Wage growth trends downward from 3% to 2%, while unemployment declines from 7% to around 5%, with a sharp rise in 2020.

Exhibit 3: Annual House Price Movements

Line chart showing property price growth trends for Sydney, Melbourne, and overall from 2004 to 2022, with peaks around 2010 and 2021 and notable fluctuations.

Funding Costs

The RBA injected a huge amount of capital, around $465 billion, into the local economy during the peak of the COVID pandemic. This – alongside huge social support and infrastructure spending by the state and federal governments, and disruption in global logistics – has been the main driver of inflation, which has reached its highest rate since the early 1990’s. With effective full employment and inflation not under control, the RBA is doing what it should be doing – restoring normal monetary policy. Unfortunately for debt consumers, this means much higher funding costs compared to the ultracheap rates that we have seen over the past five years.

Exhibit 4: Reserve Bank of Australia Assets

Stacked area chart showing RBA's asset composition from 1994 to 2020, with significant growth in Australian Dollar Investments leading the increase, especially from 2010 to 2020, alongside gradual increases in other asset categories.

Exhibit 5: Australian Government Bond Yield

Line chart showing interest rates for 2-Year, 5-Year, and 10-Year bonds from 2013 to 2022, with rates declining until 2020 and then spiking in 2022. 2-Year bonds are in green, 5-Year bonds in black, and 10-Year bonds in light green.

Exhibit 6: Household Income and Consumption

Line chart showing Household Debt to Income and Household Assets to Income from 1990 to 2019. Assets to Income, represented by a black line, shows a sharp rise, reaching around 13.0x by 2019, while Debt to Income, represented by a green line, rises gradually, remaining below 2.5x.

Exhibit 7: Housing Loan Commitments

Stacked area chart showing the growth of Owner Occupied and Investor Housing Credit from 1990 to 2020, with both categories steadily increasing, especially after 2010. Owner Occupied Credit is depicted in green, and Investor Housing Credit in black.
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