RBA raises rates to 1.85%; at least another 75bps increase expected before rates peak

Today’s decision by the Reserve Bank (RBA) to lift the cash rate by O.5 percentage points for a third consecutive month to 1.85%, coincides with new Australian Bureau of Statistics (ABS) data which flagged a -4.4% drop home lending in June, while residential building approvals also eased -0.7% in the month.

The RBA also increased the interest rate on exchange settlement balances by 50 basis points to 1.75%.

According to most bank forecasts, the cash rate could rise at least another 75 basis points before peaking. 

Interest rate decisions this year

Headline inflation

Today’s rate hike also coincides with Australia’s inflation rate reaching its highest level since the early 1990s, with headline inflation at 6.1% over the year to the June quarter.

The central bank expects CPI inflation to peak at around 7.75% over 2022, before bouncing back to around 3% over 2024.

While the RBA expects to take further steps to normalise monetary conditions over coming months ahead, the central bank reminds investors’ there is no pre-determined path.

Where too for house prices?

While rents are tipped to rise by as much as 10%, CoreLogic data released earlier this week reveals house prices dropping at their fastest pace since the global financial crisis.

Last month median house price in Sydney saw the sharpest value falls in almost 40 years.

“Nationally, home values are already falling at the fastest pace since the Global Financial Crisis (GFC), while Sydney values are declining at the fastest pace since at least the early 1980s, having fallen -5.3% since peaking in mid-February,” CoreLogic noted.

Loan commitments

Source: ABS

Watching key factors closely

RBA governor Philip Lowe noted widespread upward pressures on prices from strong demand, a tight labour market and capacity constraints.

In the face of low consumer confidence, declining house prices and higher inflation, Lowe expects household spending to continue to be a key source of uncertainty.

“The board will be paying close attention to how these various factors balance out as it assesses the appropriate setting of monetary policy,” Lowe said.

3.3% still expected in 2023

In line with the market’s expectations, today’s rate hike adds another $140 to the monthly interest bill on a $500,000 mortgage, $708 for $750,000, and $944 a month for a household with a $1m loan, once passed on to borrowers.

Today’s rate hike is also expected to see variable mortgage rates under 3% rapidly disappear.

Governor Lowe also reminded investors that a “neutral” cash rate is the level at which monetary policy is neither contractionary nor stimulatory to the economy.

However, financial markets are pricing in a cash rate at 3% by December, and peaking at about 3.3% by March, before again heading lower later in 2023 as higher borrowing costs offset rising costs.

Bonds yields

Following the RBA’s cash rate decision, Australia’s 10-year yields dropped 10 basis points to 2.95%, after trading above 3.3% last week.

Meantime, Australia’s five-year yield has dropped -4.58% to 2.77%, while 1-year yield has dropped -1.47% to 2.34%.

Where does today’s rate hike leave investors?

While fixed income return forecasts in many regions are 1.5 percentage points higher, Vanguard senior economist Alexis Gray expects slowing growth momentum and rising interest rates to create more angst for investors.

However, on a more positive note, Gray reminds investors that lower current equity market valuations and higher interest rates, herald slightly higher long-term returns in comparison to previous modelling.

“Our 10-year annualised return forecasts for global equity markets are largely 1.5 percentage points higher than at the end of 2021,” Gray noted.