Behind the Reserve Bank’s interest rate hike

The Reserve Bank of Australia’s decision to increase its official interest rate for the first time in more than a decade had been widely expected.

The only so-called unknown was exactly when the RBA would move its cash rate higher.

The cash rate is the set interest rate applied to unsecured overnight loans between banks and other financial institutions.

By lifting its official rate from a record low 0.1 per cent to 0.35 per cent, the RBA became the 41st central bank in the world this year to do so.

More than half of the central bank rate rises this year have been in the last month alone, and more rates rises are almost certainly on the way.

In fact, just hours after the RBA’s move, the Reserve Bank of India raised its main lending rate by 0.4 per cent to 4.4 per cent.

And, just a day after the RBA’s rate move, the U.S. Federal Reserve Bank, the Central Bank of Iceland, and the Central Bank of Brazil, all acted to lift their official rates too.

Their rates rose respectively to 1 per cent, 3.75 per cent, and 12.75 per cent, with the U.S. rate rise of 0.5 per cent (the second by the Fed so far this year) the biggest U.S. increase in more than 20 years.

On Thursday the Bank of England raised its official rate by 0.25 per cent to 1 per cent, their highest level since 2009 and the fourth consecutive increase since December.

Why are interest rates rising?

The common thread behind the decisions of the RBA and other central banks to raise their interest rates is surging inflation.

Inflation– the general increase in the prices of goods and services – has been on the rise globally for some time, but especially over recent months.

There are multiple factors at play. Improved business and consumer demand since the onset of the COVID-19 pandemic in 2020 has inflated prices generally.

Higher economic growth has led to reductions in unemployment levels, which has resulted in higher average wages.

At the same time, COVID-19 has severely disrupted global supply chains (particularly the ability of businesses to produce and deliver their goods and services).

The latest COVID-19 lockdowns in parts of China have significantly reduced industrial production there, which has flow-on consequences throughout the world.

And geopolitical events, primarily the Russia-Ukraine war, have led to soaring fuel and energy prices, which in turn are feeding into higher transport and utilities costs and flowing through to businesses and households.

The latest data from the Australian Bureau of Statistics shows domestic inflation rose by 5.1 per cent over the 12 months to the end of March.

The overall figure included a 13.7 per cent increase in transport costs, a 6.7 per cent rise in housing prices (reflecting higher materials costs), and a 4.9 per cent gain in furnishings, household equipment and services.

U.S. inflation is currently at 8.5 per cent, the highest level in 40 years, and in the U.K. inflation is at 30-year high and is set to hit 10 per cent in months, according to the Bank of England.

Next rate steps

Australian financial institutions have been anticipating one or more official rates rises for months, and had already begun raising their longer-term fixed-term mortgage rates well before the RBA’s official rate rise announcement.

Banks and other institutions quickly announced that they will be passing on the RBA’s full 0.25 per cent rate rise to their mortgage customers.

More rate rises are on the cards, and will continue to be dictated by both global and economic factors.

RBA Governor Dr Philip Lowe noted that now was “the right time to begin withdrawing some of the extraordinary monetary support” that was put in place to help the Australian economy during the pandemic.

Late last year the RBA was still holding its fire on rates, stating it wouldn’t lift the cash rate until actual inflation was sustainably within its target range.

“The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time,” Lowe said last week.

“This will require a further lift in interest rates over the period ahead.

“The 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.”

If interest rate increases will impact you, call us today on 07 3202 2470 to discuss your financial future.

Source: Vanguard May 2022

Reproduced with permission of Vanguard Investments Australia Ltd

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