The RBA’s interest rate hike darkens the economic outlook for Australia
Despite headline inflation cooling since late 2022, central banks including the Reserve Bank of Australia have kept hiking interest rates well into the final months of 2023 due to concerns about sticky core inflation.
The last mile of monetary policy tightening is very likely to be the most difficult, since risks are increasingly two-sided – hike interest rates too much and the economy could slump, don’t hike enough and elevated inflation could last longer than expected.
Over the last fortnight, major central banks chose to hold interest rates at current levels rather than hiking further. In the United States, the Federal Reserve held rates steady despite the economy growing at a rapid pace. Broadly, a strong economy and cooling inflation have kept hopes of a soft landing intact for the US.
The European Central Bank and the Bank of England also held policy rates steady as core inflation cooled but, unlike the Fed, both are constrained by weak growth and considerably weaker economic outlooks. It is possible that the Fed, ECB, and BOE will have to hike interest rates further in the coming months based on international factors such as the unrest in the Middle East and domestic factors linked to tight labour markets. The current pauses are therefore best described as hawkish.
On Tuesday, the RBA broke away from the pack by hiking the cash rate to 4.35%. In fact, the RBA has not been in sync with its peers through the tightening cycle — it started hiking interest rates later and paused earlier than each of the Fed, ECB, and BOE. But the Australian context has also been different for several reasons:
- Australia’s relatively high share of variable rate mortgages means that monetary policy is transmitted more quickly and is heavier on households with outstanding mortgages. Outstanding mortgage rates in Australia have increased much more than in the US or Germany, where borrowers have locked in lower rates for longer, and almost as much as in Norway, where some 90% of outstanding mortgages are subject to a variable rate
- Annual core inflation peaked at a higher rate in Australia than in the US, UK, Eurozone, or Canada (see chart below), despite weaker nominal wage growth. Core inflation in Australia has been higher than in each of these economies since the December quarter of 2022 (barring the UK which experienced an uptick in core inflation in mid-2023), but inflation in Australia has been driven by supply-side factors such as a shortage of housing which cannot be solved by dampening demand through higher interest rates
- While the US, UK, and Eurozone economies witnessed a slowdown in quarterly core inflation in the September 2023 quarter, Australia saw core inflation accelerate and exceed the forecasts of the RBA. However, supply constraints continued to account for most of the inflationary pressure during the quarter, and despite the increase in the quarterly inflation rate the downward trend in annual inflation continued
- Domestic demand has weakened considerably in Australia. Household spending has flattened over the last couple of quarters and is likely to stay weak as consumers cut back on discretionary spending and dip deeper into savings to meet daily essential spending needs.
These idiosyncrasies mean the RBA’s decision to increase the cash rate further will disproportionately weigh on renters and households with outstanding mortgages, while the supply-side problems driving inflation are unlikely to be solved anytime soon.
Australia will start 2024 with a rising share of households entering financial stress, and economic growth is likely to remain muted through the first half of next year as a result. Deloitte Access Economics’ view is that a weak economy will require lower interest rates in the second half of 2024. A ‘higher for longer’ approach could unnecessarily deepen the economic slump in Australia.
Chart: Annual inflation, Australia and international comparisons
Source: ABS, BLS via FRED, ONS, Eurostat, Statistics Canada
This newsletter was distributed on 9th November 2023. For any questions/comments on this week's newsletter, please contact our authors:
This blog was co-authored by Lester Gunnion, Manager at Deloitte Access Economics.
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