On 1 November, the RBA Board increased interest rates by 25 bps. They still expect inflation to peak around 8 percent later this year but they are hoping that strong domestic demand and a tight labour market will moderate so that they won’t have to raise interest rates too much further.

What the RBA said

“As is the case in most countries, inflation in Australia is too high.”

“Global factors explain much of this high inflation, but strong domestic demand relative to the ability of the economy to meet that demand is also playing a role.”

“Given the importance of avoiding a prices-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.”

“The Board expects to increase interest rates further over the period ahead. It is closely monitoring the global economy, household spending and wage and price-setting behaviour.”

Statement by Philip Lowe, Governor: Monetary Policy Decision, 1 November 2022.

What to expect next

The October rate increase made sense

The RBA said in October that it was hoping to have the space to wait and see how the 250 bps increase in interest rates since May would impact the economy. But with an increase in household final expenditure of 2 percent in the June quarter GDP (released 7 September), rising retail figures for August, a continuing strong labour market in September, and their own private forecasts they felt the need to raise the cash rate by 25 bps in October. They could not afford to do nothing.

As does the November rate increase

Last week, inflation hit its highest level in 32 years, reaching 7.3 percent in the September quarter (year-ending). Even the RBA’s preferred inflation measures, the weighted median (5.0 percent) and the trimmed mean (6.1) increased significantly. This largely explains why it chose to increase rates this month.

But there are reasons to think rate rises may be slowing down

Much of the 1.8 percent increase in inflation for the September quarter comes from the supply side - demand is not the main issue, which means an interest rate rise can only do so much. The RBA will continue to hope that these supply side issues will be resolved in the medium term.

While petrol prices fell for the first time in two years, gas and other household fuels were up 10.9 percent for the quarter as the impact of the war in Ukraine on international gas prices continued. Furniture prices rose 6.6 percent because of continued supply chain issues. Food prices continued to rise with a 3.2 percent increase in the quarter. Fruit and vegetable prices will remain under pressure because of continuing flooding in Australia.

The RBA is also expecting inflation to peak later this year which if it happens will take a lot of pressure off for future rate rises next year.

It will also take heart from declining inflation expectations. The Melbourne Institute found that consumer inflation expectations fell again in October while NAB’s survey of business expectations for 3-monthly inflation fell in the September quarter.

Further, going forward and as they stated in October, the RBA would prefer to wait and see the impact of past increases than be forced to increase interest rates again. Interest rate changes typically don’t impact the economy until two to three months after they are made.

Besides inflation It may come down to household spending and wages

Of course if inflation does not peak in the December quarter and hits new records next year or if the December result is much higher than the predicted 8 percent, the RBA will be forced to raise rates to show the public that it is tough on inflation and won’t let it get out of control.

However, future interest rate rises will also likely depend on whether household expenditure continues its rise in the September quarter (released 7 December) and whether the tight labour market and inflation leads to any significant increase in wage growth.

Household expenditure increased 1.5 and 2.2 percent in the March and June quarters A big contributor has been a post-covid boost to spending on air transport services (60 and 37.3 percent). This is certainly not helpful on top of the supply-side issues pushing up prices. The RBA will be hoping that this spending settles down.

The wage price index has increased by 0.7 percent (seasonally adjusted) for the last three quarters, which is its highest level since 2014. Further, inflation expectations for union officials were up in the September quarter and they will be keenly watching the passage of the Albanese government’s “Secure Jobs, Better Pay” Bill which will likely strengthen unions’ position in enterprise bargaining. If wages show any significant jump going forward, the RBA will spring into action to head off a late 1970s and early 1980s style prices-wages spiral.

Impact of the rate increase on the Australian Private Debt Market

The RBA’s interest rate increase means that Australian private debt continues to be a good hedge against the very high inflation rate. This is because private debt typically uses a floating interest rate to its borrowers. The RBA has found that the major banks and small banks have passed on the cash rate increase in full up to July to their small business rates.

Further, with the economy continuing to be in positive territory, the threat of non-performing loans is not a concern at this stage.

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