Are eight RBA cash rate rises really likely?

A former board member of the Reserve Bank of Australia (RBA) has forecast that Australia’s central bank could raise the nation’s cash rate eight times over the next few years.

Writing for the Lowy Institute for International Policy, Mr John Edwards put forth his theory that the RBA could raise Australia’s cash rate eight times over 2018 and 2019, with each 0.25% jump taking the cash rate closer to a goal of 3.5% – what Mr Edwards describes as a more “natural” rate for economic growth and inflation.

Why it could happen:

Other countries are tightening rates

A pattern appears to be emerging among the world’s central banks. The US Federal Reserve has raised America’s benchmark interest rate twice at its recent meetings, and more are expected in the pipeline. The UK’s Bank of England is also weighing up the value of raising rates.

Canada, whose economic similarities with Australia include falling commodity prices and rising house prices, is reportedly also looking into increasing its interest rate, which the Bank of Canada has kept at just 0.5% for the past seven years.

Current rates don’t match growth forecasts

The RBA is optimistic about Australia’s economic future. With the worst of the GFC behind us, a great deal of business investment is picking up, despite the decline in mining investment.

According to the minutes of the RBA’s June meeting:

“Although year-ended GDP growth was expected to have slowed in the March quarter, reflecting the quarter-to-quarter variation in the figures, members noted that economic growth was still expected to increase gradually over the next couple of years to a little above 3 per cent per annum.”

According to Mr Edwards, if these economic predictions are accurate, then the current 1.5% cash rate is too low.

Why it may not happen:

Economic outlook may be overly optimistic

If the RBA is likely to raise the cash rate in line with growth in Australia’s economy, then slower growth would mean lower rate rises, which Mr Edwards acknowledges:

“The pace of tightening will anyway be governed by the strength of the economy. If household spending weakens, if the long-expected firming of non-mining business investment is further delayed, if the Australian dollar strengthens, if employment growth is persistently weak, then the trajectory of rate rises will be less steep and the pace less rapid.”

Rapid rate rises would mess with mortgages

While many Australian banks and lenders have recently been increasing their variable interest rates out of cycle with the RBA, in part due to regulatory factors, if the RBA was to dramatically raise the nation’s cash rate, more interest rate rises would be on the cards for Australia’s mortgages.

And when you consider the record-high levels of household debt that presently exist in Australia, including a high percentage of interest only loans, the impact of a sustained series of major rate rises would be significant, to say the least.

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