By Leon De Wet

With the economy motoring along, it’s only natural that the RBA would want to normalise monetary policy and keep Australia’s recovery on track as we emerge from the pandemic.

Rising inflationary pressures have however prompted the RBA to indicate that rate hikes to be delivered over the next 18 months will be increasingly aggressive.

Will these hikes be nothing more than tapping the brakes? Or could they cause a major slowdown in the economy?

Rising inflationary pressures have seen increasingly aggressive market pricing in recent months of the rate hikes to be delivered by the RBA over the next 18 months, with a cash rate of 3.5% now forecast by the end of 2023.

For context, it is 0.85% currently.

So, is this realistic? In our view, probably not. In the past 30 years the RBA has never delivered rate increases of that size and certainly not within an 18-month period.

Now just because it has not happened before clearly does not mean it cannot.

So, what would a 3.5% cash rate mean? Assuming a full pass through of the cash rate increases, standard variable mortgage rates would be above 6.0%. This would significantly reduce the disposable income for most Australian borrowers with a home loan.

In fact, the RBA’s latest Financial Stability Review presented analysis which estimates that a 2.0% increase to variable rate mortgages would result in 20% of borrowers experiencing increases of 40% or more to their required monthly payments.

Needless to say, the negative impact on disposable income from a 3.5% increase would be even more severe.

Given that Australia is a consumption driven economy, the negative impacts would undoubtedly be broadly felt. Cash interest rates are absolutely going higher, but we don’t think the RBA will risk economic growth by pumping the brakes too hard.

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