When will Australia's cash rate stabilise? And what is a 'normal' interest rate?

There has been much speculation surrounding the Reserve Bank of Australia’s (RBA) recent monetary policy decisions. As we navigate global pressures on our economy, it’s reasonable to inquire where Australia stands and when things will return to normal? But just what is “normal”?

Notable events such as the global pandemic and Russia’s war in Ukraine have destabilised a range of industries, causing supply shortages and inflationary demands worldwide.

Australia’s headline annual inflation increased sharply during the second quarter of the year, sparking concerns we may see the return of stagflation: a shrinking economy suffering high unemployment and soaring inflation - an economic concept not experienced since the 1970’s.

RBA governor Philip Lowe has, on a number of occasions this year, advocated “normalising monetary conditions” by withdrawing some of the fiscal support that was put in place to help the Australian economy weather the pandemic.

The RBA has hiked the official cash rate 175 basis points since May, from 0.10% to 1.85%. Prior to this year’s decisions, the last time the cash rate was increased was back in November 2010.

Upon further investigation of the historical data we can determine that the average cash rate between 1990 and 2022 was 3.86%, peaking at 17.50% (January 1990) and falling to a record low of 0.10% (November 2020). Is something in the range of 4% the sweet spot to aim for? How does this 30+ year average compare with Lowe’s assessment?

What's normal?

During a media scrum on the monetary policy decision to increase the interest rate in May, the RBA governor said he expected a more “normal cash rate” to sit at about 2.5%. However, he clarified his comments and stated that he didn’t want to be pinned down on a particular number.

“I think it's quite plausible that the neutral real interest rate is positive. If the economy can generate reasonable productivity growth, I'm sure the neutral real rate is positive. So my hedging here is really around the fact that I don't really have a good handle on what underlying productivity growth in Australia is likely to be. The higher it is, the higher will be the neutral real rate,” he said.

“I think it is at least in real terms zero, which would mean that we'd have to get back to 2½ percent. And whether we need to have interest rates higher than that, it remains to be determined, but it really comes down to what you think underlying productivity growth is.”

Lowe also revealed that the RBA was determined to return to “business as usual” as soon as possible with regards to future cash rate decisions.  

“In the past, 25 basis points was the standard amount we moved. We deviated from that various times in the past because circumstances required it, but 25 basis points is the standard move,” he said.

However, for the past three months the RBA has raised the cash rate by 50 basis points each time to 1.85% in August. Some economists suggest that it will exceed 3% by the end of the year.

Lowe proclaimed Australia’s economy has performed better than anticipated this year and that this was the catalyst for the RBA backpedalling on its claims that rates would not rise before 2024.

Rising rates and soaring inflation

“The unemployment rate has come down. The economy has been strong. Australians have been resilient, they've adapted and interest rates are normalising much quicker than we thought was going to be the case,” he said.

“The main tool for adjusting monetary policy is back to the cash rate and we're returning to this world of normal where interest rates move around because of the outcomes on inflation and on the labour market and that's going to be our tool of choice from now on.”

Inflation is affecting every aspect of Australian finances at the moment, from the cost of lettuce to home loan rates. The RBA predicts that inflation may hit 7% by Christmas and that it won’t begin to fall until at least early-to-mid next year. When do the experts think it will reach its peak?

The big four banks are predicting more hikes in the coming months and into next year. Some economists speculate that Australia could enter a mild recession by the end of 2023. Preparing for financial hardship can put you in a better position to tackle any challenges that come your way.

Better understanding what causes interest rates to rise may help you to decide when to borrow money from the banks, for example home loans, personal loans, car loans and credit cards.

If your home loan's interest rate is making your repayments unaffordable, consider comparing refinancing options.

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