RBA hikes by 0.25%: What does this mean for a potential recession?

The Reserve Bank of Australia (RBA) raised interest rates by another 25 basis points at their latest monetary policy meeting this week, citing the need to combat high inflation before conditions worsen and recession becomes reality.

The official cash rate was increased to 2.85 per cent in November, the seventh consecutive hike since the RBA began bumping up interest rates in May this year - when the cash rate hovered at an all-time low of 0.10 per cent.

In a speech at the Reserve Bank Board dinner earlier this week, RBA Governor Philip Lowe explained that boosting rates was necessary to tame inflation and its economic consequences:

“This morning, we also discussed the consequences of not raising interest rates, and allowing high inflation to persist and become entrenched in expectations. If this were to happen, the evil of inflation would be with us for longer and the eventual increase in interest rates needed to bring it down would be greater. This would increase the risk of a severe recession and a sharp rise in unemployment. It would be much better to avoid such a costly outcome and so we have acted strongly to avoid it,” Lowe said.

Looming global recession

In October, the International Monetary Fund (IMF) forecast global growth to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023 - the weakest growth profile in more than two decades, except for the global financial crisis and the acute phase of the COVID-19 pandemic.

The world’s three largest economies - the United States, China, and the Euro area - have been slowing sharply, with a 75 per cent chance of recession in the US, according to UNSW Business School Associate Professor Konark Saxena.

“High US interest rates will put pressure on countries to either increase domestic interest rates or accept a substantially devalued currency because capital chases currencies with relatively higher interest rates,” Saxena said.

In the United Kingdom economic activity contracted at its fastest pace in almost two years in October, the Financial Times reported. These figures suggest that the country has fallen into a recession during a period of political uncertainty and high energy and borrowing costs.

Despite the challenges facing the global economy, Australian Treasurer Jim Chalmers declared Australia was in a strong position to combat the headwinds of recession. 

“It’s not our expectation that the Australian economy will go backwards,” he told reporters last month. 

Could we see the return of stagflation?

In his remarks earlier this week, Governor Lowe cautioned that if inflation swells and larger rate rises are needed, “this would increase the risk of a severe recession and a sharp rise in unemployment.” There’s a term for these combined circumstances - stagflation.

While it is a worrying prospect and we may see elements of this concept on the horizon, it’s unlikely that Australia will be subjected to outright stagflation. Our economic circumstances have changed dramatically since the 70s - when this economic cycle last occurred - and we’re better informed to deal with disruptions to the global economy, such as Russia’s invasion of Ukraine, global energy and supply chain issues, and the COVID-19 pandemic.

More rate hikes needed to quell inflation

The national target inflation rate is 2-3 per cent, on average, over time. Maintaining inflation at this level is intended to achieve price stability and promote steady economic growth.

Despite already raising the cash rate by large, half percentage point increments for four consecutive months this year, Australia’s central bank advocates that further hikes are needed.

“The Board’s base case remains that interest rates will need to go higher still to bring inflation back to target and our forecasts have been prepared on that basis. We are not on a pre-set path, though. If we need to step up to larger increases again to secure the return of inflation to target, we will do that,” Governor Lowe said.

The RBA’s decision to return to single rate rises (25 basis points) at the October and November meetings was in stark contrast to overseas central banks that have been hiking interest rates by even larger increments. This is partly due to Australia’s individual economic situation but also because the Board meets more frequently than most of its peers.

So, when can we expect monetary policy to stifle ballooning costs and return purchasing power to the people? Although fiscal policy decisions can take years to have a lasting impact, we may be able to observe the effects of the recent rate hikes on inflation as early as next year.

The big four banks have all cast their predictions for the next few years of cash rate movements. We may see a cash rate beginning with a ‘3’ by Christmas. And for the average owner-occupier paying a variable rate, your home loan rate could reach 6.61% by early 2023.

How are things shaping up for the future?

The economic issues we are currently facing are likely to be temporary and Australia can be expected to fare better than most countries, according to Australian National University Visiting Fellow Steven Hamilton in a recent article published on The Conversation.

“It [Australia] is less exposed to the energy price shocks than Europe and the United Kingdom, and to some degree, being a big energy exporter, benefits from high prices,” Hamilton said.

However, some market analysts suggest Australia may experience a mild recession by the end of 2023, so it’s worthwhile getting your finances under control ahead of any potential downturns.

It’s likely we’ll see further interest rate rises this year. Many borrowers who applied for loans before rate hikes returned in May are likely to be paying interest rates close to or above the serviceability buffer their lender tested their application on. This means homeowners could be paying more in interest than they could reasonably afford.

Significant property price declines may continue, further reducing equity shares for mortgage holders and driving Australians to refinance their home loans. If you’ve switched lenders but now want to go back, you’ll likely need to begin the entire refinancing process all over again.

The recently released federal budget outlines the financial approach the government will take to secure Australia’s economic future. Despite recessionary fears, there are seven significant insights to be drawn from this plan.

Many Australians are worried about the cost of living, contemplating different ways to cut expenses and save a dollar or two. But where can you make the most effective cuts to your household budget and maximise savings?

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