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Another interest rate hike... and more to come

RBA governor Philip Lowe gestures while discussing interest rates.
RBA governor Philip Lowe has little choice but to keep raising interest rates. (Source: Getty) (Lisa Maree Williams via Getty Images)

The Reserve Bank’s (RBA) 50-basis-point increase in official interest rates takes the cash rate to 1.35 per cent, the highest it’s been since June 2019 and up 125 basis points in the past three months.

With inflation set to hit a 32-year high above 7 per cent and the unemployment rate at a 48-year low - under 4 per cent - easy monetary policy is no longer needed.

It is as simple as that and the rate hikes mean the RBA is getting the cash rate closer to what is termed ‘neutral’ levels of interest rates - around 2.5 to 3 per cent.

Also by the Kouk:

Indeed, the case is unquestionable that tighter monetary policy is needed from the RBA if some of the heat is to be taken out of the economy, which is a necessary precondition for inflation to eventually return to the 2-3 per cent target set by the Government and the RBA.

This suggests the RBA will need to deliver an additional 125-150 basis points of interest rate hikes and it needs to do it quickly.

The central bank is well behind the curve, which makes rate hikes in the next few months all but certain.

On July 27, the June-quarter inflation data will be released and these are set to show a 2 per cent rise in inflation in the quarter, which will bring annual inflation to well over 6 per cent, a 30-year high.

This, together with what is likely to be a strong labour force release next week, will lock in a further 50-basis-point hike when the RBA board meets in early August.

There is no doubt the banks will pass on the latest interest rate rise to variable mortgages and business loans.

In isolation, higher interest rates will take some heat out of the housing market.

This is why it is still likely that Australia-wide house prices are likely to drop by around 7 per cent from peak to trough, with further, more extreme falls, unlikely because of the strength in the labour market and the interplay of slowing supply - as construction falls - and stronger demand - from a recovery in immigration.

Indeed, it is noteworthy that house prices are still rising in Perth, Adelaide, Darwin, Canberra and Brisbane, even if prices are marginally lower in Sydney and Melbourne, and are flat in Hobart.

The reasons for this very soft landing for housing is linked to the support for prices from a buoyant labour market, a very tight rental market - which will attract investors - and the slow growth in supply relative to demand, the latter being aided by a rebound in international migration.

And, in any event, the RBA does not pay much attention to house prices. Its focus is more on inflation and the labour market, although it will look to see whether any wider-spread wealth erosion is impacting household wealth and spending.

The good news for inflation and estimates where interest rates will peak are signs of a sharp fall in global commodity prices.

The price of oil, timber, metals, energy, agricultural products is down by around 10 to 20 per cent in the past month.

This is likely to flow through - with a lag - to consumer prices.

As things stand, annual inflation is likely to peak around 7 per cent in the December quarter 2022 and there is likely to be a sharp deceleration in inflation into 2023.

The speed at which inflation slows will be driven by several factors. The rate hikes delivered from the RBA will be crucial, but also important are the pass-through effects of the falls in commodity prices.

It looks a safe bet that by the end of 2023, inflation will be around the 2 to 3 per cent target, but that is based on the RBA hiking the cash rate to 2.5 to 3 per cent in the next few months and commodity prices easing a little more.

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