Rate rises are now coming in quickly with the cash rate having risen from 0.1% in April to 1.85% in August. Interest rates are now the highest they have been since 2016. And while these increases are not unexpected, with debt levels at record highs, there is no doubt many of us are wondering when interest rate increases will stop.
The problem is of course inflation which continues to run at a red hot rate. Last week, June inflation came in at 6.1%, the highest annual rate since 2001. The only consolation was the June quarterly increase slowed a little bit from the March quarter. It is however now significantly above the two to three per cent band that the Reserve Bank of Australia aims for and will take some time to come down.
The main tool to get inflation under control is monetary policy, and more particularly changes to the cash rate. Unfortunately interest rates can only control the demand side and it is the supply side that is more problematic. The two main drivers of inflation right now continue to be fuel costs and construction costs. Both of which can be pushed down by slowing down the economy but are unlikely to come down quickly just using this means.
Fuel costs increases are largely out of our control and with no end in sight to the war in Ukraine, are likely to remain high. The cut to the fuel excise levy has made some difference to pricing but is set to cut out in September at which time petrol prices will rise further again.
Construction costs increases are being driven by a range of factors and the complexities of these increases are problematic. Initially the main drivers were both supply and demand driven. Cashed up homeowners led to record levels of renovation approvals while HomeBuilder led to very high demand for new homes. At the same time, problems emerging with construction began to emerge. These include a lack of timber due to the 2019/2020 bushfires, too few construction workers and supply chain blockages.
While interest rate rises are putting a damper on demand for renovations and new homes, we are now seeing an increase in construction company insolvencies and this is flowing through to developer insolvencies. Getting the construction industry back on its feet will be a long process.
Our Federal Treasury’s latest forecasts show inflation to peak at 7.75% by the end of the year but it will take some time for it to come back down again. In the June quarter, rental increases remained under control however rental shortages are apparent throughout Australia and advertised rents have risen by 13% over the past 12 months. By next year, this is likely to flow through to inflation, adding further pressure.
The difficulties in predicting when inflation and interest rates will start to stabilise became most recently apparent when two major global organisations came out with very different forecasts for 2023. In their most recent “Global Economics Prospects” report, the World Bank lowered their forecasts for growth and warned that the world was in for several years of below average growth and above average inflation. In contrast, the OECD was more positive and forecast that inflation should start to ease by the end of the year.
As to when interest rate rises will end, I personally prefer the OECD’s outlook with inflation peaking at the end of the year and a slow down in interest rate rises at the same time. For now however, we are looking at continued increases in interest rates until the end of the year.
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