Australian Interest Rates: How high will they go?

Since the global financial crisis (GFC) in 2008, low interest rates have been consistent in Australia. When the global Covid-19 pandemic hit in 2020, the Australian Government pushed through stimulus packages into the economy and the central bank reduced interest rates even lower. With Covid settling, demand in the housing market was strong and house prices boomed, but in the rest of the economy supply chains remained restricted and input costs problems were augmented by geo-political tensions. This resulted in supply not being able to keep up with demand and pushed inflation rates higher and broader than was expected and for a longer period of time than anticipated. In order to try to control inflation, the central bank responded by lifting interest rates and tightening monetary policy. It appears that inflation is likely to ease.

Internationally, inflation in the US has started to decrease since June 2022 (over 9%) to October (7.7%) and this suggests that domestically interest rates may not rise as high and as quickly as expected.

The Reserve Bank of Australia (RBA) board in the November 2022 meeting raised the cash rate by 0.25% resulting in a cash rate of 2.85% which was lower than many people expected. This lower thane expected cash rate rise suggests that key inflation pressures on the economy (in particular wage growth) will be less impactful in Australia than it has been internationally. In contrast to this, Australian households have been more sensitive to interest rate rises than homes internationally, with the trend in Australia towards variable rate loans. Comparing to the US, most borrowers are on 30-year fixed loans.

We are seeing in the Australian economy that interest rate increases are starting to have an effect in helping to restore price stability. In their recent statement though, the RBA said that it will be a challenger to return inflation to the past rate of 2-3% whilst “keeping the economy on an even keel”. The RBA concluded that steps in achieving this balance is “a narrow one and it is clouded in uncertainty”.

In the housing market we are seeing a correction in house prices that is slowly deepening and broadening across Australia, with capital city house prices falling by 1.4% in September 2022, a 4.3% decline in the third quarter of the year. Financing approvals are mirroring this price correction as well, with declines in investor and owner-occupied home loans.

Where does this leave Australia and our economy? It appears that inflation will be higher for longer than was originally expected. This means that interest rates are expected to continue to increase but at a slower rate than they have to correct inflation, with the BRA resetting their view on the cash rate along over time. Economists are predicting the cash rate to increase to between 3.1% – 3.85% in the first half of next year, remaining stable until early 2024 when the RBA policy will pivot resulting in lower interest rates by early 2024.

Analysis by Canstar proposes that a cash rate of 3.85% results in an average variable interest rate of 6.73%. To put this into terms for your mortgage, a difference between a 5.73% and 6.73% variable home loan interest rate is $650 per month on a $1 million, 30-year term loan.