WEEKLY E-MAIL

6 May 2022

INTEREST RATES SET TO TAKE OFF

By Karen Maher

For the first time in 11 years – since November 2010 – the Reserve Bank (RBA) Board has increased the cash rate by 0.25% to 0.35% and indicated a further lift in interest rates over the period ahead is expected.

With inflation higher than expected, the Reserve Bank said now was the right time to begin withdrawing some of the extraordinary monetary support put in place to help the Australian economy during the COVID pandemic.

The Consumer Price Index (CPI) rose by 2.1% during the three months to the end of March and by 5.1% over the year to March, rising at the most rapid rate since the introduction of the GST over 20 years ago.

Higher inflation has been driven by a series of significant events, most notably Russia’s invasion of Ukraine, Australia’s floods, pre-COVID pent up demand for goods and services and supply chain issues.

The RBA revised their central forecast for 2022 for headline inflation up to around 6% and underlying inflation of around 4.75%, and by mid-2024, headline and underlying inflation to have moderated to around 3%. These forecasts are based on an assumption of further increases in interest rates, aiming to put downward pressure on inflation to the target band of 2-3%. The RBA Board will continue to closely monitor the incoming information and evolving balance of risks as it determines the timing and extent of future interest rate increases.

Financial markets are pricing in a cash rate of 2.5% by the end of the year. That implies another two percentage points of hikes over the next six meetings, which would mean a hike every month for the rest of the year.

Three critical dates before the RBA’s next meeting on 7 June will provide further economic indicators; the quarterly wage price index on 18 May; the Federal Election on 21 May, and the quarterly estimate of key economic flows in Australia, including gross domestic product (GDP), consumption, investment, income and saving on 1 June.

While bad news for borrowers, an increase in interest rates represents good news for depositors. Deposits from households stood at a record $1,261 billion in March, up by 12.3% from a year ago, with Aussie families accumulating $272.4 billion worth of savings during the pandemic.

Despite the likelihood of rate increases over the next year, the outlook for economic growth in Australia remains positive. Macroeconomic policy settings remain supportive of growth, and higher commodity prices are boosting national income.

The US Federal Reserve also increased its cash rate this week by 0.50%, raising the central bank’s rate to a target range of 0.75% to 1.0%, the biggest increase in 22 years. Despite a slowdown in the US economy over the first few months of the year, household spending and business investment remained strong, with the annual inflation rate 8.5%.

It is fair to say share markets have had a difficult start to 2022. Markets are currently facing a four-way collision of the pandemic, a geopolitical crisis (Ukraine), significant COVID lockdowns in China and now an interest rate tightening cycle due to inflation shock. Markets will likely see an increased level of volatility during this period driven by the uncertainty of what increasing interest rates mean for both domestic and global growth.

Karen Maher
Associate

If you have any questions or comments, please email me at karen@gfmwealth.com.au

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