Why interest rate hike affects you: Reasoning behind RBA’s cash rate increase

While most were expecting a rate increase on Tuesday, the 0.5 per cent hike caught many off-guard. Here’s why the RBA locked in such a sharp jump.

While both everyday Australians and experts were expecting an increase when the Reserve Bank of Australia updated the official interest rate on Tuesday afternoon, the stark hike of 50 basis points caught many off-guard.

At 0.85 per cent, the official cash rate was lifted to its highest level since September 2019 and marked the first back-to-back rate rise in 12 years. Prior to the announcement, experts believed the rise would be closer to 25 or 40 basis points.

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Speaking to the ABC, BetaShares chief economist David Bassanese said the sharp jump was the RBA’s attempt to “inflict shock and awe on the economy”.

“No doubt with a view to eliminating any lingering complacency with regard to the inflation outlook,” he said.

“Indeed, today’s decision is a bolt from the blue and stands in marked contrast to the RBA’s recent soothing words with regard to the outlook.

“It is now acting out of clear alarm and is not frightened to show its alarm.”

In response to the new cash rate, Westpac became the first big four bank to pass on the rate increase in full, announcing a 0.50 per cent increase to its variable interest rates from June 21.

The remaining three major banks – Commonwealth Bank, ANZ and NAB – are expected to follow suit and pass on the rate rise in full.

From 21 June, we will increase home loan variable interest rates by 0.50% per annum for new and existing customers.

— Westpac Bank (@Westpac) June 7, 2022

What inflation has to do with it all

It’s no surprise that inflation was a key factor which contributed to the severe rate rise – something RBA Governor Philip Lowe addressed himself.

“Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected,” he said.

Speaking about what has contributed to the rate hike, Mr Lowe listed “global factors” like the Ukraine war and Covid-related disruptions to supply chains, but added that domestic issues were also at play.

“[There were things like] capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices,” he said.

“The floods earlier this year have also affected some prices.”

He also said that inflation was expected to increase further, before declining towards the preferred bracket of “2-3 per cent range next year”. Measured by the Consumer Price Index (CPI), household inflation rose by 2.1 per cent, to 5.1 per cent in the March 2022 quarter.

A continued uptick in inflation could also spell more bad news for consumers already struggling with cost of living pressures.

“Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago,” Mr Lowe said.

Budget relief flagged

Speaking in the aftermath of the rate hike, newly installed Treasurer Dr Jim Chalmers acknowledged its impact on “Australians who are already facing skyrocketing costs of living”. He estimated that households with a mortgage of $330,000 will need to pay an extra $87 in interest feeds. That amount increases to around $157, for those with a mortgage of $595,000.

Dr Chalmers also flagged that some relief measures will be coming in Labor’s revised budget in October.

“I will hand down a budget in October and a key part of that will be a cost of living package around childcare and medicines, trying to get power bills down, over time, trying to get real wages growing again,” he said.

Difficult news for homeowners already facing skyrocketing costs of living, including spiking energy prices. A better future awaits but first we have to navigate together this inflation challenge we inherited, and the rising interest rates that accompany it. #ausecon#auspol

— Jim Chalmers MP (@JEChalmers) June 7, 2022

Rate rise ‘just a taste of what’s to come’

Despite the shock of Tuesday, the consensus among experts is that interest rates are likely to increase further. Previously the RBA tipped inflation to hit 6 per cent by mid-2024, with interest rates to rise in tandem.

By Christmas, some experts have predicted that the official cash rate could hit 2 per cent. Others have even extended this to 2.7 per cent.

Future monthly rate rises are also likely, said APAC economist at Indeed Callam Pickering.

“With inflation at a two-decade high, the RBA will hike rates aggressively over the remainder of this year,” Mr Pickering said in a statement.

“Rate hikes in both May and June are just a taste of what’s to come.”

Australians can expect more cash rate increases throughout 2022. Picture: Muhammad Farooq/AFP

The question, however, is whether the increased interest rates will calm inflation.

“Australia has imported high inflation from abroad and that is not typically a channel through which the RBA has tremendous influence,” he said.

“Compounding matters, markets are pricing in a cash rate of 2.7 per cent by the end of the year. If the RBA hikes rates at a slower pace – which they almost certainly will – then the resulting depreciation of the Australian dollar will put upward pressure on inflation.”

Who will be affected the most?

According to PropTrack economist Paul Hurst, Australians in their late-20s and early-30s, newly minted mortgage owners and young families would likely feel today’s interest rate hike the most.

“The standard model is that spending increases for people until their mid-50s anyway and then decreases after that,” he said.

“People around that late-20s to early-30s age bracket are typically taking on more responsibilities so their spending will have increased dramatically as they’ve taken those things on.

“That’s when things like mortgage payments, demands for money for childcare etc. are likely to be highest for people.”

New homeowners and people with young families are likely to feel the rate hike pain the most. Picture: NCA NewsWire/Joel Carrett

However, Mr Hurst also said that the costing increase was an attempt for the Reserve Bank to quell inflation concerns in the long run, which would hopefully bring down prices quicker.

“The bank wants to maintain full employment, but also lower and stabilise inflation – that’s why their job is so difficult because often those goals can counter one another,” he said.

“It’s a challenging period. There are so many pressures on the cost of living on top of both interest rates and energy prices now increasing too.”

How will borrowers be affected?

For mortgage holders, Tuesday’s cash rate rise will have a direct and almost immediate effect. There are certain suburbs and areas which will likely be more likely to suffer from increased mortgage stress.

This is defined by “having less than 5 per cent of ordinary income left after covering your repayments and ordinary day-to-day costs,” said housing advocacy group Everybody’s Home spokeswoman Kate Colvin.

While NSW is Australia’s most indebted state, specific areas will be hurt more than others.

“Regional NSW and outer Western Sydney will be particularly hard-hit by these rises – especially lower-income communities which stretch right through the hinterland and up the coast of NSW,” she said.

Speaking to The Daily Telegraph, Digital Finance Analytics principal Martin North also made the grim prediction that once rates pass 2 per cent, nearly 50 per cent of all Australian homeowners fill fall into mortgage stress.

“We’ve got more than four million households out of nearly 10 million who are already close to the edge – that’s an unprecedented situation,” he said.

“If we assume the RBA adds 2 per cent, or just about that, another 400,000 to 500,000 would probably fall into that stress category.”

Originally published as Why interest rate hike affects you: Reasoning behind RBA’s cash rate increase