Experts fear multiple interest rate increases could plunge Australia into surprise recession
One hike will hurt. Two will be a new level of pain for suburban Australia, particularly younger households who are only just returning to stable financial footing.
Unlike the last rate hike cycle, if rates move again then unemployment will rise as the AI rollout gives extra momentum to white-collar job losses. House prices will stall and all the green shoots of recovery in laggard states like Victoria will quickly wither and die.
This is simply nightmare stuff for the federal government, and worse still for debt-heavy state governments that need to roll over tens of billions of dollars in debt financing over the next two years and were also banking on rate relief.
This is not pre-Christmas gloom. This scenario, while still slim, is being spoken about openly inside the top echelons of major banks: multiple rate rises are possible.
This would turn Australia’s soft landing into a resounding thud and a recession would certainly follow.
Two separate but broadly linked developments in recent days have added weight to this theory. Hot inflation and the bank regulator’s effort to impose lending curbs are proof that the economy is running ahead of itself – and it may continue to get worse.
At the very least, the prospect of any rate cut next year is now dead in the water.
“Pick your poison,” one top bank executive says of interest rate rises. “Take one or two early – or five or six, later on.”
Already there were growing doubts within the Reserve Bank that inflation wasn’t going away as hoped. All was on track as it fell inside the top of RBA’s target zone earlier this year, but from June it reversed and started pushing steadily higher again. That reversal followed a rate cut in May and another in August which took the cash rate to 3.6 per cent.
The latest inflation numbers confirmed the RBA’s worst fears. Inflation has punched back above the target band of 2 to 3 per cent and is picking up speed. For October, the seasonally adjusted figures came in at 3.3 per cent, while the market had been tipping 3 per cent.
There’s one important qualification: it’s the first time the ABS has released its full version of its benchmark quarterly inflation numbers as a monthly series, so it’s possible the figures are still in their teething phase. The RBA has previously maintained that it will put more stock in the quarterly numbers until it gets used to the quirks of the monthly series.
Still, it’s the trend of inflation that’s the real worry. It reveals an uncomfortable truth: there’s no spare capacity in the economy.
The latest inflation numbers had financial markets doing a U-turn. Just four weeks ago futures markets were piling bets on one more rate cut by mid next year. Those bets are off, and the money is starting move into the likelihood of rate rises.
National Australia Bank chief economist Sally Auld is among the more hawkish of the big bank economists. For months she had been sitting in the “hold” camp; she now believes there’s a growing case for an increase, possibly by June.
Other economists at brokerages UBS and Barrenjoey are now predicting a rate rise in 2026 as a greater certainty.
For her part, Auld argues the RBA’s determination to engineer a soft economic landing – no recession and the preservation of the jobs market – by refusing to lift the cash rate as high as other economies in a similar inflation bubble, is now what is causing Australia’s inflation heartburn to return.
While not unprecedented, soft landings are historically quite rare in the decades since inflation targeting became the focus of central banking. Australia’s situation represents new economic territory for financial regulators, businesses and households.
“While the RBA deserves credit for engineering a soft landing, it would be naive to believe that soft landings are not without their challenges,” Auld says.
Namely, soft landings leave an economy already at “full capacity” as their starting point, which caps the ability to grow faster than long-term trends.
This has implications for households, businesses and governments: as spending rises again, the economy hits capacity constraints, inflation breaks out again and the cycle becomes harder to contain. This is exactly where Australia is. It is close to or at full employment, spending is strong and inflation is becoming harder to control.
“There is no short-term solution to the challenges presented by the soft landing,” Auld says. In the long run, improving productivity or adding more supply and skills to the jobs market can ease the economic bottlenecks.
To many the economy may like feel like it’s booming, but hot property markets are also the thing which drove bank regulator APRA to impose lending speed limits. The regulator called around the major banks on Wednesday night to give them a heads up that a crackdown was coming, which was unveiled the next morning.
From next year, the proportion of each bank’s housing lending that goes to borrowers with a debt-to-income ratio of six times or more will be capped at 20 per cent. That is, no more than 20 per cent of a bank’s lending book can be made up of the higher-leveraged loans.
The policy exempts new construction and is largely targeted at property investors. APRA is understood to have become increasingly worried about property prices surging faster than incomes, particularly in hot spots Sydney and Perth.
All the major banks currently sit comfortably below the limit, which makes the rules more symbolic than practical at this stage. But the hurdles can just as easily be moved, or other tools – like putting an absolute cap on investor credit growth – can be introduced.
The economy has moved from warm to hot in a short space of time, and the last thing RBA governor Michele Bullock wants is to shift her bank from a position of cutting rates to increasing them.
For central banks, sudden policy reversals without a major external shock seriously undermine financial credibility and represent and even bigger hit to business and consumer confidence.
The last time there was a short gap between a RBA rate cut and hike was following the September 11, 2001 attacks in the US when rates were lowered as an emergency measure. There it took just four months between rates being cut in December that year and rises beginning in April the following year.
Expect Bullock to ramp up the rate hike warnings after next month’s board meeting. If that doesn’t work then she may be forced to act. Twice.
johnstone@theaustralian.com.au
RBA reverses course on rates and hints the next move is likely up
Brace for the bad news. It’s possible that a cash rate rise is coming as early as May. And it gets worse: there could be another some time after that.