Over the past two years, it’s been hard to see an end to interest rate rises. Homeowners have been slogged with one mortgage increase after another.
Despite a couple of months of calm, another potential rate rise is looming on the horizon, with the imminent release of inflation data and a meeting of the RBA in early August.  Kat Clay and Trent Wiltshire, Deputy Program Director Economic Prosperity, discuss whether the interest rates will ever go down again, or if homeowner hell will keep going for a long time to come.
Transcript
Kat Clay: Over the past two years, it’s been hard to see an end to interest rate rises.
Homeowners have been slogged with one increase after another. Despite a couple of months of calm, another potential rate rise is looming on the horizon with imminent inflation data and a meeting of the RBA in early August. I’m Kat Clay and with me is Trent Wiltshire to discuss whether the interest rates will ever go down again, or if homeowner hell will keep going for a long time to come. So, Trent, I’m really glad you’re joining me today because I wanted to talk about interest rates for a while.
And there’s this potential rate rise coming. There’re a few things that feed into whether the RBA raises the cash rate at any given time. And two of the major factors are the unemployment rate and inflation data. So, I know that new inflation data is coming on Wednesday, but how is the economy looking more broadly at the moment?
Trent Wiltshire: So, you know, overall, very simply, I’d say the economy certainly softening but aggregate demand is strong, and that inflation is still too high. So, you mentioned, you know, the RBA. potentially going to raise rates. So just to take a step back in terms of what the RBA looks at, it’s got two interlinked goals in terms of what it’s trying to do.
It’s trying to get consumer price inflation of two to 3 percent per year, and also to hit full employment. And that is roughly defined as the maximum level of employment that is consistent with low and stable inflation. So, there it’s two goals. So, it’s battling at the moment, trying to stop the unemployment rate rising too much. But also, to get inflation down.
So just to dive into the labour market, what’s happening there. So, the unemployment rate is 4. 1%, which is up for around 3. 5 percent a year ago. labour demand has softened job vacancies and recruitment activity is falling. So, you know, it’s weakening, but it’s still in good shape.
The unemployment rate of 4 percent and low underemployment is probably close to full employment or even maybe a little bit better. The June quarter inflation data is out on Wednesday and that’s the really key data release. And that will really determine whether the RBA raises rates the following week or, keeps them on hold. So, the latest quarterly data we have for inflation is from March, which seemed like a while ago now, and that had the inflation at 3. 6 percent over the year, but underlying inflation and the more important measure inflation and stripped out the volatile price rises that was actually 4 percent a year. So that’s well above the RBA is targeted around 2. 5%.
We do have some monthly data for April and May. Which we get from the monthly CPI indicator. So, it’s an indicator. It doesn’t give us a full sample of what’s going on, but it gives a good signal. And the May data in particular was stronger than expected. Headline numbers rose. Underlying inflation was still a bit strong at around 4%. So, it does suggest that inflation is going to remain a bit too high for the RBA’s liking.
Kat Clay: So, the question on everyone’s minds, do you think the interest rate will go up in August? And why is that?
Trent Wiltshire: Yeah, it’ll, I think it’ll get a lot of discussion this week in and around the Olympics content as well, but my view is that rates won’t go up. And that’s purely because the RBA has really shown it’s reluctant to raise rates. It does seem content to have inflation falling slowly back down to that two and a half percent target.
So, an important thing to remember with the RBA setting interest rates is that interest rates actually hit the economy with a lag, and that lags typically gets to be around 12 to 18 months. So, the RBA is setting rates for where it thinks the economy will be in mid to late 2025. But what the RBA will do really, we’ll really depend on these inflation numbers that we’ve just spoken about.
I think we see underlying inflation for the June quarter of around 1 percent or higher, which is about 4 percent over the year. I think they’ll hike. So that’s what a number would show that yeah inflation is sticky. It’s, it’s hanging around and the RBA will need to do more. So, I’m probably leaning towards the fact that they should raise rates knowing that we’ll, we’ll see the inflation data soon, but I think they’ll, they’re really reluctant to.
Kat Clay: So that’s really interesting to me that you think that they should raise rates, but they are reluctant to, I mean, you’re not the only economist out there. What do other economists and financial markets think the RBA will do?
Trent Wiltshire: The financial markets think there’s about a 20 percent chance of an interest rate increase to 4. 6%. And then they also have the, the markets have rate cuts priced in from around mid-2025.
Economists not surprisingly, they’re a bit divided. So, I think it’s, it’s probably good to think about economists being in two camps of what the RBA should do. The first camp is that the RBA shouldn’t raise rates any further. They’ve done enough. And that goes to the fact that, you know, the economy’s slowing.
The labour market is weakening, and inflation is falling, although kind of slowly. So, you look at the economic data, consumer spending’s flat, housing construction activity is weak, GDP growth is only around 1%. So, some economists are saying, why would you cut rates when it’s clearly, clearly the case that the economy is slowing and we know inflation is falling, even though it’s taking a little while.
So, on the RBA’s forecast, they think that inflation will hit two and a half percent by mid-2026. So, it’s still two years away, but it is trending that direction. So that’s one camp. The other camp is that look, the RBA hasn’t done enough. Inflation has been too high for too long and it’s taking too long to come down.
As a result, inflation is going to be stuck in this sort of three to 4 percent range rather than that two and a half percent target. For too long and the reason that this camp think that’s bad is that the RBA will lose its credibility that it can hit its inflation target of two and a half percent.
And that’s been its core goal for the past almost 30 years now to hit that inflation target around two and a half percent. Inflation stays you know, above 3 percent around 4 percent for one two, you know, be sort of hitting 3, 4, 5 years by the time 2025, 2026 comes around. That means the RBA might start to lose its credibility and credibility is critical for central banks. It affects expectations. If people think the RBA operates on base that people will assume that inflation will average two and a half percent. So, people will set their prices according to this, but if expectations become unanchored because of the lack of credibility on the RBAs part, that’ll really make the next downturn tricky or the next surge of inflation.
So, there are some signs of this occurring. So Deutsche Bank just released some research showing that trust in the RBA’s 2 3 percent inflation target has never been this low for this long. And that’s based on a survey of households done monthly. if we have the credibility of the RBA lost, that will really have a, you know, a bad long-term impact.
That’s where the second camp sits.
Kat Clay: I think that’s really important context for the conversations that are going to be going on this week and the next around that just to understand where people are coming from in, in the thinking around the economy. It’s fascinating too, this idea, that people can lose trust in the central bank as something we, we perceive as something as so rigid and sturdy.
A stalwart comes to mind as kind of the word you described it, describe a central bank with. So, we’re going to talk a little bit more about the role of the RBA in a second. If it’s not too speculative, I mean, when do you see interest rates potentially going down?
Trent Wiltshire: There’s been a lot of very incorrect forecasts over the past five years. But I, you know, I’d think 2025 is, is likely. You look overseas, we seem to be about six months behind what’s happening overseas. Rate cuts are much more priced in to, you know, what’s going on in the US or Europe.
Some countries have started to cut rates. So, I’d think 2025, but I won’t name a, I won’t name a month.
Kat Clay: I think that’s wise. I mean, you know, we’re not fortune tellers here. I, I would hate for some lovely podcast listener to come back to us in 2025 and
Trent Wiltshire: Yeah. Fortunately, it’s not, it’s not Grattan’s role. A lot of people, a lot of different people and smart people spend a lot of time thinking about where the RBA is heading, not particularly Grattan’s point, but we, we do certainly follow it because it clearly matters for what’s happening across the economy.
Kat Clay: And we’ve talked previously about how homeowners have to often bear the brunt of inflation management measures.
Is this fair?
Trent Wiltshire: It’s not fair. And that’s the, the simple truth. So, you know, monetary policy, it’s a blunt tool. The RBA has only got one lever and that blunt tool is about hitting that inflation target and full employment and you know, it’s not about fairness. That’s, that’s kind of not what they really consider. Fairness or redistribution, that’s the government’s role. They should be thinking about who, you know, who wins and loses from what’s happening in the economy and how we set different policies for that. So, you know, the fact of the matter is that homeowners with a mortgage, particularly those people that have bought recently, at high prices with a big mortgage facing rising rates.
They’re the ones that have really suffered from the surge of inflation and the consequential rising interest rates. If you think about it more broadly, like high inflation has costs across society. That’s why we don’t like it. And we’ve seen that with consumer sentiment surveys show that people really hate inflation.
Kat Clay: I was going to say, I do love that we had to do a survey to find out that people hate inflation.
Trent Wiltshire: Yeah, I think it’s, it’s in some ways it shows the RBA success that the fact we haven’t had to think about inflation. That’s kind of, I guess, a very simple way to think about what the RBA goal would be is to have people not even think about inflation, just not trust that it’s going to be around two to three per cent a year. That’s where you set your expectations.
We haven’t had that for the past few years. We’ve had inflation, you know, skyrocket and it’s shows, you know, when people’s living standards go backwards, they really hate it. And it’s, it’s so salient seeing these price rises. I think of boring things like insurance price rises have been significant and that’s an essential good for almost everyone.
Food costs have risen and moderating now a bit health costs as well. So, all these things in the basket of goods means that, you know, inflation’s hurt different people by different amounts. But then interest rate rises to combat that, you know, really hurt those mortgage holders.
There’s a lot of focus on these mortgage holders and what interest rates do, but that’s only one way actually interest rates set to affect inflation or to change the inflation rate. So that’s known as the cashflow channel. Higher rates mean mortgage holders have less to spend. That’s takes demand out of the economy.
Another channel is known as the savings and investment channel. Simply higher rates mean households are more likely to save. Interest rates are more attractive. You’re more likely to put money in the bank. For businesses, higher rates when you’re less likely to invest. So that takes demand out of the economy.
The wealth channel, when we see rates rise, typically that means asset prices will start to fall. So that’s things like share prices, house prices. When people feel less wealthy, they’ll spend less. Note, this hasn’t really happened this time. Interest rates have been overwhelmed by things such as, you know, changing preferences for housing, which has pushed up house prices. So that sort of made that channel not work as well.
Then the exchange rate channels. So higher rates mean a stronger Australian dollar. Which means our exports are more expensive. So that’s less demand for exports. Again, you know, just recently the, the dollar has fallen and that’ll actually put upward pressure on inflation.
The other channel is the expectations channel, which I’ve spoken about just before about, you know, the credibility of the RBA and that two and a half percent inflation rate.
Kat Clay: Yeah, and it’s, it’s kind of like a perilous seesaw at times, managing all these different things going on, you know, with exchange rates and then, you know, a lot of consumers, they don’t have even extra money to put away into savings because they’re spending it on their mortgages. So, it will be interesting to see how the RBA manage all of these things going forwards.
One of the things that I found fascinating is that the Greens are calling for Jim Chalmers to step in and stop the RBA from another rate rise. And, and my brain, I was like, can, can they actually do that? Can Jim Chalmers step in and, and interfere with the RBA? I thought it was meant to be independent.
Trent Wiltshire: The government can do it. It has power under the Reserve Bank Act to step in and to demand changes to interest rates as it sees fit. They’ve never used that power before. There’s actually legislation before the parliament now to actually remove that power from the government and that record or that change arose from the Reserve Bank review that was, happened over the past couple of years and there’s legislation before parliament now to implement a lot of those changes that includes changes to how the board operates and other things. It can be done, but yeah, it certainly goes against the idea of an independent central bank, which is, which came in in the 90s. So, you know, I think that type of interference is really a bad idea. Keeping the RBA independent from government is critical to maintaining low and stable inflation. And there’s clear evidence that that from overseas. So, the reason we do that is because governments don’t like making unpopular decisions.
So, you can imagine at the moment if the government had the interest rate lever, they would not be raising rates, even though it may be necessary. So, we’d probably see much higher inflation over the time. So that’s why we took interest rate lever out of the government’s hands. So, the RBA, the technocrats, can set rates according to what they think the economy needs, not according to sort of the political influences of the day. I’ll note that, you know, the RBA is independent, independent but there’s still some level of accountability. So, they appear before parliament the governor and the board are appointed by the Treasurer. So, there’s certainly some oversight there but they operate independently in setting those rates.
Kat Clay: Yeah. And as you’ve said, it’s very important that they are independent. That leads very nicely into my next question, which is about the upcoming federal election. I mean, cost of living has been flagged as one of the major items for the upcoming election. How do you see rate rises or a rate rise affecting the campaign?
And would the RBA be brave enough to do that? Raise the rates before an election.
Trent Wiltshire: I think the first one is when the election is going to happen. We certainly there’s lots of speculation on maybe an early election. There was speculation in August, but August is approaching very quickly.
Kat Clay: Well, have they speculated August is the election?
Trent Wiltshire: Yeah, there was a speculation, but you know, the September period is sort of blocked out by footy finals. So, there’s not many slots, but you know, potentially an early election.
Kat Clay: This is most Australian thing ever is that we cannot have federal election while footy finals are on.
Trent Wiltshire: There’s more important things in life than the election. You can see the government thinking, let’s try and get the election in before any rate rises happen that that could be a thinking. You mentioned, would the RBA be brave enough to raise rates?
Well, we have seen them do it before, actually. So, in 2022, the RBA raised rates during the election campaign. That was the first rate rise in more than 11 years. Famously or infamously, the RBA raised rates during the 2007 election campaign.
Kat Clay: Can you give me a little context on that 2007 one? Cause you say it’s famously, but I actually don’t know why it’s famous.
Trent Wiltshire: I’d say if I was, because I think it really showed the RBA asserted their independence. One of the, you know, a real testing time, the economy is heating up quite a bit. There was probably speculation about, you know, would the RBA step in given the election was so close? But they did. And I think in a, in some ways actually raising rates close to an election, shows that the RBA is independent of government and actually asserts their authority or independence. If they needed to, they would be willing to raise rates, but you know, if they aren’t, if the election is in 2025, more likely maybe see a cut and that’s certainly what the government would be hoping for. The opposition, not so much.
Knowing that, you know, there has been changes, the RBA now only meets every six weeks or so, rather than every month, so there’s, you know, a lower chance of it actually happening, but, you know, it could happen if it, if the timing worked out.
Kat Clay: We will be avidly following the election here at Grattan and of course, bringing you more commentary as time goes on and major election issues are raised.
Just one final question for you, Trent. I mean, is there anything the government could be doing right now to slow down inflation and encourage the RBA to reduce interest rates?
Trent Wiltshire: Yeah, Kat, there certainly is. The federal and state governments, they could both be running much more contractionary budgets. That’s the sort of broad macro policy they could be or implanting to reduce pressure on, on the RBA to raise rates.
Kat Clay: So just when you say contractory, do you mean like smaller?
Trent Wiltshire: Yes, you’re taking money out of the economy. So, you think the Commonwealth ran a surplus in 2023 24? So that seemed to think, look, they’re taking money out of the economy. The government is taxing more than they’re spending. But there was actually lots of discretionary spending in that budget.
So, they could have chosen to take more out of the economy if they wanted to, but instead they spent money on different things. So, for example, there was the $300 energy rebate, stage three tax cuts came in. Popular decisions, certainly benefit some people, but in aggregate adds the demand in the economy and that all else, all else equal means there’s more luck that the RBA will keep rates high or raise rates.
Over the past two budgets, there’ve been surpluses. But roughly about 20 billion in extra spending over the past two budgets, and that’s about 1 percent of GDP. Looking forward again, more discretionary spending. That’s a factor in high rates. The RBA doesn’t like to say it explicitly, but it’s factored in as part of their forecast.
Trent Wiltshire: Steve Hamilton, a prominent Australian economist called the recent May budget, the most irresponsible budget in recent memory. So, it really goes, it really goes to show that Commonwealth could be doing more in terms of trying to pull money out of the economy. The states are also to blame. So, states also spending too much.
The Queensland government, one policy, you know cheaper public transport fares coming up, Victorian government, 400 school saving bonus. So, these state governments also spending money when they probably should be pulling out. And that would also ease pressure on the RBA. These policies by governments are done under the guise of cost-of-living relief.
And it’s a really tricky one because as I just explained, adding money to the economy is expansionary. It means the RBA is more likely to raise rates. But I also mentioned the government’s job is to think about redistribution and fairness. So, we know there’s some big losers from high rates.
The Government can choose to spend money in different ways to help different groups of people. Yes, the fact that more spending means higher rates means mortgage holders get hurt the most. But some of the money might be going to people that are really struggling under high inflation, say, renters facing massive rent increases.
So, you know, it’s a, it’s a value judgment from governments in terms of where they spend this money. You know, but in aggregate, if they taxed more, spent less, rates would probably be lower, and they might not be going up as well.
Kat Clay: I think too, it’s about the visibility of those decisions as well. I mean tax more, spend less works well for economists, but probably not for politicians who are trying to get re-elected. On that note, I have really enjoyed this discussion with you, Trent. It’s always great talking about the RBA and the economy in general.
If you’d like to see different topics on our podcast, please email us at media@grattan.edu.au. If there is anything you’ve always wanted our Grattan staff to talk about, we’d love to hear from you. As always, please do take care and thanks so much for listening.