Property News, Insights & Education

    The Future of Interest Rates: What to Expect in Australia

    One of the more bizarre aspects of the hype surrounding the departure of former Reserve Bank governor Philip Lowe and the appointment of his replacement was the suggestion that Michele Bullock would somehow be less willing to increase interest rates.


    When her appointment was announced in July, unions and the social services sector said it marked the opportunity for a “reset”.


    “In the last 14 months we’ve seen 12 interest rate rises. That can’t go on,” ACTU Secretary Sally McManus boldly declared at the time, as reported in The New Daily.


    Cassandra Goldie from the Australian Council of Social Service put it like this: “I don’t think that we’ve seen the rate rises that are already now locked in flow through; we haven’t seen the full effect of those yet.”


    So much for a “reset”!


    So what’s happened in the two months since Michele Bullock officially took over from Philip Lowe in September?


    Well, she’s already presided over an RBA board decision to increase rates by another 25 basis points, taking the cash rate to 4.35% - the 13th rise since May 2022.


    Ms Bullock has been extremely frank about the threat inflation poses to the Australian economy and the willingness of the RBA to act to bring it back within the 2-3% target the bank aims for.


    In fact, the RBA Governor has put herself on a collision course with the Federal government, rejecting their analysis that Australia’s inflation challenge is being largely driven by external factors, like the disruption to global supply chains and higher oil prices, as a result of wars in the Middle East and Ukraine.


    “Homegrown” inflation


    “The remaining inflation challenge we're dealing with is increasingly homegrown and demand driven,” she told the Australian Business Economists Annual Dinner in Sydney recently.


    “Hairdressers, dentists, dining out, sporting and other recreational activities - the prices of all these services are rising strongly,” she warned.


    To underline her point, she shared the RBA graph you see below.




    If you look at the light orange component or “Services” section of the Consumer Price Index graph, you’ll see the cost of services - like haircuts, visits to the dentist and restaurant meals - have been going up, as the price of “selected goods” - which includes groceries - is shrinking.  


    As Channel Seven News put it, “The Reserve Bank's new boss is warning Australians they're spending their way to extra interest rate rises.”


    The people providing those services argue they’ve had to put their fees and charges up because their input costs have gone up.


    But it’s pretty clear Ms Bullock believes things may need to get to a point where people balk at the high price of haircuts and will start leaving their locks untamed.


    The only real lever the RBA Board has to try to curb this surge in “homegrown inflation” is interest rates, and in her Sydney speech, Michele Bullock admitted that’s far from ideal.


    “I also know that interest rate rises are squeezing the finances of households with a mortgage.”


    “But while the Board recognises there is a wide diversity of experience, the Bank’s statutory objectives are economy-wide outcomes, and our key tool – the interest rate – is a blunt one,”

    she said.


    A few days later, at a gathering of central bankers in Hong Kong, Ms Bullock appeared to wind back that concession, stating that Australian households with a mortgage weren’t really suffering at all because of higher interest rates, and complaints about mortgage stress were “political noise”.


    “Despite that noise, households and businesses in Australia are actually in a pretty good position.”


    “Their balance sheets are pretty good,” she said.


    The interest rate outlook


    So what does this mean for interest rates?


    Well, most pundits are still tipping that the RBA will keep rates on hold at its December board meeting, and use the summer break (the RBA Board doesn’t meet again until February next year) to better gauge the impact on the economy of the 13 rate hikes so far.


    That view was strengthened by the release of monthly inflation figures on the 29th of November and retail sales figures the previous day.


    They showed inflation in the year to October 2023 was 4.9% - coming in below most forecasts - while retail spending fell slightly (0.2%) from the previous month.


    BetaShares Chief Economist David Bassanese said it was his view that the monthly CPI figures, “confirm that the RBA won't raise rates at the last meeting of the year in December.”


    But CBA Economist Stephen Wu cautioned against reading too much into volatile monthly numbers:


    “The RBA Governor’s concerns around services inflation as noted in her recent speech–particularly prices at hairdressers and dentists, dining out, sporting and other recreational activities, won’t see price updates until later in the quarter”, he wrote in a market update. 


    Nevertheless, of the big four banks, only the NAB currently thinks rates will go higher in this cycle, peaking at 4.60% in February next year, before finally edging down to 3.10% by Feb 2026. 


    The CBA, Westpac and the ANZ already believe rates have peaked, but like the NAB, they all predict that it will take a considerable amount of time (18 to 27 months) for rates to ease substantially. 


    The CBA is the most optimistic, saying rates will drop 150 basis points to 2.85% by May 2025.


    Westpac says it will take longer - 2.85% by December 2025.


    And the ANZ says rates will have only fallen 100 basis points by June 2025 to 3.35%


    This is a far cry from what the Big 4 were predicting earlier this year.


    For example, in March, NAB was predicting rates would peak at 3.6% and then ease to 2.85% by June 2024, while Westpac forecast rates of 3.35% by the same date. 


    So what’s changed?


    The simple fact is most market watchers, and even the Reserve Bank, did not predict that inflation in Australia - whether it be “homegrown” or coming from global, external sources - would be so persistent for so long.


    And interestingly, the people that are betting huge amounts of money on the future of interest rates in Australia - money market traders - currently do not believe rates will ease anytime soon.


    This is a graph of the implied yields on 30-day futures trades on the Overnight Cash Rate at the close of the market on the 29th of November. 

     cash_rate_dec_4_23 (1)


    Historically, the Overnight Cash Rate has generally been the same as the RBA’s Official Cash Rate.


    So you can see that as far out as April 2025 - 17 months from now - the “smart money” is that Australia’s official cash rate will still be at least 4%.


    Interestingly, this view is backed by a new report from the large economics team at the OECD in Paris.


    They believe interest rates have peaked in Australia, but they are forecasting that the RBA will keep the cash rate at the current 4.35% UNTIL inflation is back in the Bank’s 2-3% target range.


    The RBA has set itself a deadline of December 2025 to achieve that goal.


    The takeaway…


    The point I am trying to make here is that regardless of what the RBA board announces on the 5th of December, rates are unlikely to be cut substantially anytime soon. 


    So if you currently have a variable-rate mortgage and are only just managing to meet your now higher loan repayments, the good news is interest rates are unlikely to go much higher.


    The bad news is - for the next few years at least - you may have to find yourself a cheaper hairdresser and dentist, take your own lunch to work and get used to watching your favourite sport on television, instead of cheering on from the stands with an overpriced beer in one hand and an expensive hot dog in the other.


    You can console yourself with the knowledge that because of high population growth and a continuing chronic housing shortage in Australia, the value of your home is very unlikely to go backwards.