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Interest rates are going up: What you can expect

·4-min read
RBA governor Philip Lowe discussing interest rates at the National Press Club.
RBA governor Philip Lowe is set to announce an interest rate hike in the coming months. (Source: Getty)

We know the Reserve Bank of Australia (RBA) will be hiking interest rates over the next few years. The debate now is about when it starts the hiking cycle, how quickly it moves interest rates higher and what peak rate will be delivered.

With inflation running strongly and set to hit its highest rate in 30 years, it is obvious the monetary-policy-tightening cycle will need to deliver a hefty dose of interest rate rises before the RBA can be confident inflation will return to the 2-3 per cent target range.

Also by the Kouk:

The money market futures, which price these sorts of issues into their investment decisions, are factoring in 3 percentage points of interest rate hikes by the end of 2023.

And, along the way, expect the cash rate to end 2022 at or around 2.0 per cent.

When the first rate rise does occur, it will be the first for around 12 years and, because of that, many borrowers - and savers for that matter - will need to reassess their financial position in the new era of higher interest rates.

History of rate-hiking cycles

Since the early 1990s, there have been four interest-rate-hiking cycles in Australia:

  • October 2009 - November 2010: 13 months, 175 basis points of hikes taking the cash rate from 3.0 per cent to 4.75 per cent.

  • May 2002 - March 2008: 5 years, 10 months, 300 basis points of hikes taking the cash rate from 4.25 per cent to 7.25 per cent.

  • November 1999 - August 2000: 10 months, 150 basis points of hikes taking the cash rate from 4.75 per cent to 6.25 per cent.

  • August 1994 - December 1994: 4 months, 275 basis points of hikes taking the cash rate from 4.75 per cent to 7.5 per cent.

A few issues stand out when looking at those periods where the RBA delivered interest rate hikes.

One is that the duration of the cycle, from the first to the last move, has been relatively short. Just four months in 1994, 10 months in 1999-2000 and 13 months in 2009-10. The longest cycle is almost six years, in the period 2002-2008.

The rate-hiking cycles have ranged between 150 and 300 basis points.

(It should be noted that the starting point for the cash rate for each cycle was materially higher than the current 0.1 per cent rate. The upper end of this range is currently being priced in.)

The lowest peak in the hiking cycle is 4.75 per cent, which is well below the peak rate currently priced in.

3% may not be the peak

Forecasting the extent of a monetary-policy-tightening cycle ahead of even the first rate hike if fraught with risks, difficulty and massive uncertainty. It must be speculative to a large extent, even though the forecast can be founded in substantive points on inflation and the economy more broadly.

That said, given how buoyant household finances are, the clear evidence of the structural rise in inflation, the certainty of a material lift in wages growth in the years ahead, the amount of policy stimulus still embedded in the economy via the recent Budget, and the fact the RBA has been slow to start the rate-hiking cycle, a peak cash rate at 2.5-3 per cent seems a fair expectation.

The risk from this juncture is that the peak could be even higher.

Crimping inflation pressures when they are so strong globally, and indeed locally, may require more extreme monetary policy action.

Given that a neutral level of interest rates is likely to be around the 3 per cent rate currently priced in, if the RBA needs to implement restrictive monetary policy to meet its inflation target, a move in the cash rate to around 4 per cent in late 2023 or into 2024 is distinctly possible.

All up, it is a challenging time for markets as they react to the RBA’s current complacency on policy and the runoff news that points to an overheated domestic economy.

Get set for a run of interest rate rises in more months than not over the next six-18 months and for a total of at least 2.5 percentage points of hikes in that time.

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