Why is the RBA raising rates so fast and should borrowers feel hard done by?

When the RBA increases the cash rate, everyday Aussies tend to feel the impact through higher interest rates and larger monthly mortgage repayments. So why has the RBA been hiking the rate so sharply, and have people who borrowed big, believing rates would stay low, been hung out to dry?

If you’re currently paying off a mortgage, these past few months have probably brought you little joy, with all the major banks and most other lenders hiking variable home loan rates every time the Reserve Bank of Australia (RBA) has announced a cash rate increase. On the back of a further fall in the unemployment rate announced this week, many economists are forecasting another 50 basis point cash rate increase in August. Some are predicting the increase could be even higher, at 75 basis points. The increases could continue beyond August, too, meaning there is little prospect of relief in sight for borrowers in 2022.

Australia is currently experiencing rising inflation and a cost of living crisis, with mortgage stress looming for some homeowners. In the midst of all this, you may be wondering why the RBA is adding to the pressure on household budgets, and if the bank’s board caught borrowers out by raising rates much sooner than expected.

Canstar spoke with Fabrizio Carmignani, Professor of Economics at Griffith University, to ask about the rationale behind the RBA’s recent cash rate calls, and the broader context of the bank’s actions at a time when many homeowners are already feeling the pain financially. We started by discussing the backdrop of the record-low rates that Australia experienced prior to the first cash rate increase in May.

→ Related: What is the cash rate and how does it impact home loan borrowers?

Why was the cash rate so low for so long?

Professor Carmignani said that at the time the RBA brought the cash rate to an all-time low of 0.10% with three rate cuts in 2020, inflation had been under the bank’s target of 2% to 3% for some time, and the Australian economy was already running “below potential”. The significant disruption created by the COVID-19 pandemic was a catalyst for the RBA to offer a “fiscal rescue package” to the nation to stimulate economic activity and mitigate the effects of ongoing lockdowns and general disruption to businesses.

The record-low cash rate couldn’t last forever, and RBA chairman Philip Lowe told Aussies that rates would eventually go back up. However, throughout much of 2021 he also said the RBA didn’t expect this to occur until “2024 at the earliest”, due to low inflation and slow wages growth across the Australian economy. All that changed earlier this year when, amidst a backdrop of rising inflation, the RBA initiated a series of cash rate hikes in May.

Why is the RBA raising rates?

While the RBA had always signalled that extremely low rates would not last forever, the size and speed of these rises took many by surprise. In fact, the RBA’s 50 basis point rise in June was the largest single cash rate hike in nearly two decades, and the bank’s board repeated this in July.

“In the last couple of years, we have experienced unprecedented uncertainty, which in turn has made it more difficult to formulate predictions or expectations about the future, including future inflation,” Professor Carmignani told Canstar, noting that a number of “global shocks” to the world economy have driven inflation higher than expected.

These “shocks” include the ongoing disruption in supply chains and the effects of geo-political instability in Europe and elsewhere.

“As a result of this convergence of shocks, inflation has over-shot initial expectations and this in turn has called for an unexpected response, which has taken the form of a quicker and sharper increase in the cash rate,” he said.

Has the RBA let home loan borrowers down?

Most variable rate mortgage payers would have felt the impact of the recent cash rate hikes in the form of higher monthly repayments. Those now wondering where to find this extra money, when the cost of energy and most other essentials is also rising, might well be upset at the RBA’s change of tune on the cash rate. People who took out large mortgages in the period leading up to May 2022, thinking rates would remain low for a while at least, may be feeling particularly hard done-by.

Professor Carmignani said he both understands and shares the concern of home loan borrowers at this time, although he added that if the central bank wants to get inflation in line, then an increase in the cost of household mortgages is one means to do this.

“It is also important to keep in mind that the current hike in rates is a response to inflationary pressures,” he said.

“Once inflation returns within target, interest rates will likely normalise. This means that in the long-term interest rates will adjust to a lower level than the current one, albeit still above the record low of 2020.”

Professor Carmignani said that while the handling has not been perfect, monetary policy is “not an exact science” and judging decisions the RBA made during a time of crisis through the clear lens of hindsight would not necessarily be fair.

“Certainly, there are lessons that can be learnt from the past, but overall, it would be difficult, in my view, to argue that the RBA should have behaved significantly differently from what they have actually done in the last 18 months,” he said.

Others, including the federal Treasurer Jim Chalmers, do feel it’s time for an inquiry into how the RBA operates, although some of the calls for this kind of inquiry pre-date the recent round of cash rate increases.

What were the risks if the RBA had not raised rates?

Professor Carmignani said that if the RBA had not acted as it did to raise the cash rate, the main impact would have been higher inflation.

“If the RBA were inactive, then inflation would accelerate even faster, and this could lead to a spiral that gets quickly out of control,” he said.

“In turn, exponentially rising inflation has large costs on the economy and households.”

In other words, the actions that the RBA is undertaking now – raising the cash rate which in turn prompts banks and lenders to raise home loan interest rates – do come at a cost, but their aim is to prevent even higher costs in future.

Even with the RBA’s present course of action, the Australian economy is still not out of the woods. Professor Carmignani said this is because the inflation we are experiencing is being caused largely by disruptions to the global supply of goods, and not necessarily factors Australia can control.

“The Australian economy is still going well, but signs of a possible forthcoming recession are already evident in the US,” Professor Carmignani said.

“In fact, this problem is typical of economies hit by supply side shocks: inflation starts to accelerate, but the economy contracts.”

“This presents policy makers with a trade-off: higher interest rates are needed to control inflation, but these higher interest rates might also worsen the contraction and lead to a recession. A situation like this is known as stagflation, and it is indeed a very complex scenario for policymakers to deal with.”

Australian borrowers don’t have long to wait to find out what the RBA will do next. Its next decision on the cash rate will be announced on 2 August.

Cover image source: Fizkes/Shutterstock.com.