Today’s Good Money Conversation

by Milan Chetkovich and Tracey King

4 May 2022

Inflation, Cost of Living, so called “full employment” and Higher Interest Rates 

The Reserve Bank of Australia’s historic lift in the cash rate from 0.1 per cent to 0.35 per cent yesterday was no surprise to economists.  

The Commonwealth Bank, ANZ, NAB and Westpac have announced they will pass on the full amount of the Reserve Bank of Australia’s (RBA) 0.25% increase in interest rates announced on Tuesday 3 May to their mortgage customers.  

So, interest rates have just gone up.  Will there be more interest rate rises?  It is difficult to speculate on further interest rate rises, however it may be more helpful to walk in the shoes of the RBA and take a look at what is happening in the Australian economy at present. 

In this blog we aim to share some information to help you understand why the RBA has taken the actions they did on Tuesday 3 May to lift interest rates.  

What is the cash rate? It’s the interest rate banks pay to borrow from the RBA. If that is increased the banks will seek to obtain funds from an alternative source. They have to offer a higher rate to their other sources of funding – primarily term and on-call depositors. That extra cost is then passed onto the home loan borrower in their variable rate home loans.  

Where are we then with the RBA using monetary policy instruments to restrain inflation? What can they do – increase the cash rate you say!  

There is currently a lot of public conversation around phrases like monetary policy, inflation and economic demand. It’s accentuated at the moment by the fact that we are talking about these topics during a federal election period, along with the COVID-19 pandemic environment and the Ukrainian situation (and it’s flow-on into petrol costs).  

These are macro effects that have an impact on the overall Australian economic conditions. So now that we have heard the RBA has acted upon some recently published data (CPI movement) or economic conditions (COVID) using monetary policy – what does this mean?  

What does that mean? Why did they lift rates? It makes you and I pay more for our home loan (without paying any extra off the outstanding balance) and therefore we have less in our wallet for other household expenditure. Less money to spend on other items (see our first blog where we talked about reduced number of coffees per week).  It puts a handbrake on demand and hopefully from the perspective of the RBA plateaus the inflation growth. 

Well that’s the home loan effect! If you are fortunate where there is no home loan commitment and you have some savings then you may end up earning more on those reserves (savings) and have some more money to spend! Increasing aggregate demand. 

Monetary policy – the concept of “money matters” is used by the RBA to target a desired effect on the day to day Australian economic (financial) conditions. 

Right now the data released last week by the Australian Bureau of Statistics (ABS) on the movement in the Consumer Price Index (CPI) showed an unexpected rise, giving Australia an increase of more than 5% in the CPI for the past 12 months. 

Do we then say monetary policy is a blunt instrument?  How careful does the RBA have to be not to overcook matters either way? 

Well, what is the CPI? 

It’s a basket of goods and services that the ABS selects to track and measure the movement (up or down) in the price of the economy. It’s used as a measure of inflation. 

Let’s understand it’s not your basket of goods associated with your particular, specific consumption patterns in your household. It’s a basket devised to generally reflect Australia’s consumption pattern. It’s a macro look not a micro focus on a particular individual. We are talking macroeconomics here! 

What’s the macro action taken by the RBA? What’s its objective? What’s the macro strategy the RBA can undertake? 

Firstly the RBA has an objective which is deemed to assist the right economic conditions for Australians to sustain their standard of living through appropriate levels of economic growth.  That is so you can have lots of things in your “personal” basket of goods. 

How does maintenance of steady low inflation help all of us? 

The question economists are asking right now is if the current CPI increase is demand fed or cost pushed? These somewhat influence how the RBA may move over the next few months. 

Demand pull is about an increase in overall (aggregate) demand for goods and services that then flows on into higher prices.  Look at the construction sector at the moment where due to higher demand (effect of the pandemic on Australians not travelling as well those expats coming back home) for housing materials and labour (tradies).  With so much demand for their services the suppliers are now demanding a higher price for their goods and services. 

That flows into a cost push effect on the CPI.  This is further exacerbated by the supply chain problems both here in Australia and overseas. General wages don’t seem to be putting that cost push on inflation as we have had a stagnant wages profile in Australia for the past few years (since about 2014, what’s that? Some seven years!). 

Need assistance with reviewing your home loan?

If you are needing some help to review your home loan, then you should always talk to a reputable lender or licenced mortgage broker. There are also some good websites to look at to compare interest rates, such as Canstar.

#moneymanagement #wealth #goodmoneyconversation #savings

The information in this Blog is general and has not taken into account your objectives, financial situation, or needs. It is not personal advice. You need to consider whether this advice is right for you, having regard to your own objectives, financial situation and needs. You may need  it is important to check any product information directly from the product provider.  Ensure you consider the relevant Product Disclosure Statement (PDS) or other applicable product documentation before making a decision to purchase, Aquire, invest in or apply for a financial or credit product.  You may wish to seek financial advice from a suitably qualified adviser or finance broker. The writers of this Blog may receive a fee for referring you to a credit or banking provider.

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