- Inflation is expected to be more stable after the Christmas break.
- However, relief from high interest rates is not expected until the latter half of 2024.
- Most experts are broadly predicting the cash rate to remain stable or potentially one or two rises in the first half of 2024.
Australians are closely monitoring their bank balances with Christmas around the corner. Many are wondering how they are going to afford it all with the cost of living pressure heavily bearing down on hip pockets, as well as the impact of high interest rates and high inflation.
Many Australians are in a waiting pattern, putting their hopes in the year ahead and any relief that may come of it. But, with the current Government unable to bring inflation down enough to sustainable levels, we should be looking at the current monetary policy and critically reviewing why it does not seem to be as effective as hoped.
How the current monetary policy works
At the helm of Australia’s monetary policy sits the Reserve Bank of Australia (RBA), which looks at the cash rate – this is what lenders will pay to borrow funds in the money market overnight – and this acts as the benchmark rate to influence the broader interest rate environment.
When the RBA meets to decide on the cash rate (on the first Tuesday of each month except for January), they aim to influence the economy through aggregate demand, inflation, and employment.
The RBA’s cash rate decision will impact the interest rate decisions of lenders as, effectively, it costs them more to borrow cash in the money markets. So, when the RBA raises the cash rate, lenders will raise interest rates for mortgage holders and therefore mortgage holders will have less disposable income left to spend on discretionary items like restaurants, clothing, entertainment, etc.
When there is less discretionary spending occurring by the general public, the economy will start to slow down and inflation should kerb to more sustainable levels. The Government’s target inflation rate is around two per cent to three per cent over time.
Why this is not effective
When we experience a period where the RBA raises the cash rate over multiple meetings, this shows that they have been unable to effectively bring down inflation with their previous decisions.
With a target inflation rate of two per cent to three per cent, we are currently seeing Australia’s inflation rate around five per cent, after peaking at 7.8% in December 2022.
The current monetary policy just is not enough to bring inflation down to a sustainable level yet.
But why isn’t it effective? Because there are a few factors that are impacting the effectiveness of the current monetary policy.
Mortgage stress
Of course, the direct impact of the RBA’s cash rate decision is on mortgage rates, as lenders adjust their interest rate on loans to align with the cash rate.
But this only impacts those mortgage holders who have borrowings with a variable interest rate.
One of the biggest hurdles of the current policy is that during the pandemic, we witnessed historically low interest rates and many mortgage holders chose to fix their loan rates during this period.
Therefore any interest rate rises thereafter have not affected these mortgage holders at all, leading the monetary policy to be ineffective.
However, their loans aren’t fixed forever, and that’s when we will see these mortgage holders hit a “fixed rate cliff”, meaning that when they come off their fixed rate, they will suddenly be hit with a shock of a high interest rate that they may not be prepared for, or be able to afford, due to multiple rate rises during their fixed term.
Until we see mortgage holders come off their fixed rates, the cash rate decisions will be the burden of variable rate holders.
Not everyone has a mortgage
One of the biggest challenges of this type of monetary policy is that it does not impact everyone.
The last “Survey of Income and Housing” showed that 37% of Australians have a mortgage, whilst 30% own their home outright (have no mortgage) and the remaining 33% are made up of renters, living with parents, etc.
When considering these statistics, keep in mind that monetary policy impacts mortgage holders which is around 37% – and not all these mortgage holders are on a variable rate.
In this way, the monetary policy does not directly impact the majority of Australians.
Another group that it does impact are renters, and people searching to purchase a property.
Tenants are impacted when the landlord’s mortgage interest rate increases and this trickles down into the rental prices.
This also includes commercial tenants, as when the cost to lease shops and café’s increases it comes to a point where it is not affordable to operate, and we see these types of small businesses start to close.
Another group indirectly, but significantly impacted are those looking to buy a property.
Although they are currently not mortgage holders, they have an intention to be.
The lenders will need to assess their serviceability (ability to repay a loan) and at a higher interest rate it is likely the amount they will be approved to borrow will be less so they might find it more difficult to purchase a property, or they may need to save a larger deposit.
What other measures could the Government take?
Fiscal policy
Fiscal policy can be an effective policy for inflation where the Government can control spending and taxation to help with inflationary measures.
For example, during the pandemic, the Government implemented fiscal policy with financial support measures to ensure people were still spending money to assist with unemployment and prevent the crash of small businesses.
By influencing the level and types of taxes, alongside the extent and level of Government spending, as well as limiting Government borrowing, this can impact the economy and perhaps be a much more effective way of kerbing inflation than the current monetary policy.
Fiscal policy could be more effective than the current monetary policy measures because fiscal policy can have a wider reach by impacting more people in the community rather than in monetary policy where it is only the mortgage holders that are impacted the most.
If the Government considered limited debt through a strict fiscal policy, a smaller deficit could cool aggregate demand and inflation so that the RBA doesn’t need to raise the cash rate too much.
The Government could also look at the type of taxes in place and manage some taxes to assist in kerbing spending to control inflation.
Taxes can be effective to reach more of the community than monetary policy, but no one likes the sound of more taxes, and certainly, the Government doesn’t want to ruffle feathers and lose in a popularity contest by raising taxes or implementing new ones.
What will inflation look like in 2024?
The RBA take a break in January and their first meeting is in February.
We are expecting to see inflation to be more stable after the Christmas break however we are not expecting any relief in interest rates until the latter half of 2024.
Most experts are predicting the cash rate to remain stable, or there may be one or two increases in the first six months of 2024 before we might see rates start to decline towards the end of 2024.
It is not expected that Australia will reach its target of three per cent inflation until the end of 2025.
