June 12, 2023 by Dymphna

Australia is different, but not good different

The RBA’s not slowing down. There’s more pain ahead.

So the RBA just went ahead and shocked everyone last week, hiking rates by 25 basis points to 4.1%.

If you’ve got whiplash I don’t blame you. The pace of hikes, and the RBA’s aggressiveness is unprecedented. We’ve never seen anything like it.

This chart compares the current hiking cycle with all other hiking cycles in recent history. As you can see, there’s the current hike-fest, and then nothing else comes close.

But it’s actually worse than it seems.

Because Australia is different. We feel rate pain more acutely than other countries.

Monetary policy (=interest rates) does it job (slowing down or speeding up the economy to get inflation in the target range) through four channels: (i) savings and investment; (ii) asset prices and wealth; (iii) the exchange rate; and (iv) cash flow.

In Australia’s case the cash flow channel on the household sector is more powerful than most other nations on earth because of the way our mortgage market is structured.

And so while the above chart looked at the official cash rate – the rate set by central banks, the below chart looks at how that plays out in practice in the market, by looking at actual market mortgage rates.

As you can see, Australia is storming ahead. Mortgage rates have risen more in Australia than they have in any other country, apart from Norway, but we still have six months to catch them up.

So rate hikes bite hard in Australia.

And the reason that’s the case is that we have a predominantly  floating rate mortgage market. Even though a larger percentage than normal fixed rates during the pandemic, the average maturity of fixed rate loans in Australia is still shorter than most other countries.

So because so much of the market is on floating rates, when the RBA hikes the cash rate, which lifts variable mortgage rates, we all feel the pain. 

And the RBA sounded positively hawkish last week (= biased towards more rate hikes.)

They’re particularly worried about services inflation, which is refusing to come down.

In particular, they noted that this has become a global phenomenon. Services inflation is sticky the world over. And that’s true.

Which means that the RBA is not quite ready to put away the gun.

Not just yet.

I’ve been saying this for a little while. It does feel like we’re close to the top of this hiking cycle.

But we’re still in unchartered territory before. We’ve never had inflation like this, and we’ve never had a monetary response like this either.

It’s not totally clear how this is going to play out.

So my advice to people entering the market right now is don’t assume that the RBA is done and dusted. Not just yet.

Make sure you’re leaving yourself a bit of breathing space.

If that services inflation doesn’t come down, there’s still a chance that the RBA will have to hike one or two more times yet.