RBA raises interest rates for first time in a decade

Philip Lowe, Chairman of the Reserve Bank of Australia (RBA) announced yesterday that the cash rate target is now 0.35%, with real rates still very negative. This was the first rate rise since November 2010. The time has come to start withdrawing some of the ‘extraordinary monetary support’ that has been injected into the economy since early 2020. They are now forecasting inflation to peak at 6% in 2022 after annualised inflation in the last month came to 5.1%.  

In the media release, economic strength was the primary rationale for raising rates. Unemployment has declined to 4% and overall labour participation, job ads and vacancies are all at record highs. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed. Macroeconomic policy settings remain supportive of growth and national income is being boosted by higher commodity prices. In a tight labour market, wages are picking up, which is good news for workers after years of stagnation. 

Overall, the outlook for economic growth in Australia is seen as positive, despite annualised inflation picking up more than expected to 5.1%. While lower than many other advanced economies, price pressures are weighing on consumers’ purchasing power. Even with the rate rise, Australian dollars are eroding to the tune of -4.75% per annum.  

According to the RBA, the cause for the increasing inflation were global factors including the remnants of the pandemic in China and the war in Ukraine. Record increases in the M2 money supply and anaemic rates didn’t rate a mention. One has to wonder, if the RBA really sees the economic outlook as positive, why have interest rates been kept as close to zero as possible (0.10%) for more than a year.  

In keeping with the tightening theme, maturing government bonds are not going to be reinvested, and with that, the total balance sheet of the RBA is expected to drop significantly over the next couple of years. This will tighten the overall money supply which is likely to have the effect of reducing inflation, as there are fewer dollars chasing the same goods and services. The other effect it may have is to make cheap credit harder to come by which in turn affects businesses and borrowers that can only survive on depressed interest rates. A number of commentators see the RBA as likely to keep raising and tightening until something breaks, at which case a new round of QE and zero interest rates will come back with vengeance. 

In a world of stubbornly negative real rates, precious metals are one of the only safe havens. Bonds are well and truly out of the picture with almost every headline published over the last few weeks being some kind of variation on the following:

 The Worst Start to the Year Ever for the Nasdaq

  • Worst Start to the Year for Bonds Since 1990
  • Inflation Hits 40 Year Highs
  • Nasdaq Caps Worst Month Since 2008
  • A Rough 4 Months For Stocks: S&P 500 Books the Worst Start to a Year Since 1939.

These have been some very unflattering comparisons, any time you see throwbacks to 2008, 1990, and the Great Depression, you know it can’t be good. In addition, we’ve seen a lot of charts more or less looking like this one from Bloomberg: 

But more fundamentally here in Australia we now have the setup of being either #1 or 2 in the rankings of world’s highest level of private debt, most of that tied up in the most illiquid asset of all, their house, now facing rising rates amid a backdrop of inflation double that of wage growth.  The RBA talks about private balance sheets being ‘healthy’ but balance sheets and cashflow are very different things.  Unlike gold and silver, you cannot simply sell a little bit of your home to meet unexpected costs. That of course leaves drawing down on your home loan, emboldened by the recent rises in property prices, to continue to maintain lifestyle.  So to be clear, that is INCREASING your debt to maintain your lifestyle that is being hampered by the cost of servicing all your debt in an environment of extended rising rates all on the premise that property prices never go down…