How Fed interest rate hikes impact Australia?

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Highlights

  • The US Fed has increased its pace of monetary policy tightening, building speculations about RBA’s next move.
  • The US Fed and RBA conducted their first interest rate hike within a gap of just two months.
  • As Australian banks usually depend on US borrowing, higher interest rates in the US mean higher borrowing costs for Australian banks.

It is a known fact that developments in the United States (US) quickly travel across the globe and show an impact. The interest rate hikes by the US Federal Reserve (Fed) are no different as they have shown a significant impact on economies worldwide. Australia has also been one of the nations facing the consequences of higher interest rates in the US.

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In fact, interest rate hikes in the US have triggered a similar response from the Reserve Bank of Australia (RBA). The linkage between the decisions made by both the central banks is so tight that the US and Australia embraced their first interest rate hikes just two months apart. Specifically,

Australia’s first interest rate hike came two months after the Fed’s first rate hike in March. Afterwards, the Fed embraced aggressive interest rate hikes, announcing a massive hike in the latest meeting.

Just like the Fed, the RBA took a more aggressive approach in its interest rate hike cycle and raised the cash rate by 25 basis points in the May meeting and an unexpected 50 basis points in the June meeting. If the Fed’s rate hike streak is a blueprint for the RBA’s rate hike cycle, then the upcoming RBA decision could be highly damaging for households.

The US Fed conducted its largest rate hike since 1994 in June 2022, when it raised interest rates by 0.75%. Going by this rate hike, the RBA might take an even more aggressive stance in its policy decision for July. However, the RBA has stated that it would only raise rates by the necessary percentage and not beyond that.

ALSO READ: Minimum wage hike: How will it impact inflation and RBA interest rate decision?

How does US borrowing impact Australia?

The relationship between US interest rates and the Australian economy is deeper than one might think. Australia is dependent on foreign capital to fulfil its investment needs. Certain bonds and shares sold to overseas investors are sold in different currencies. Consequently, the companies issuing these shares and bonds must pay back the returns to the holders in their foreign currency.

Meanwhile, these returns are affected by the interest rates prevailing in the respective countries of the bond/share-holders. Even Australian banks borrow money from international banks, from where the amount might be received in US Dollars. Thus, if interest rates in foreign banks go up, then Australian banks would have to pay higher interest on these loans.

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In simpler terms, the banks must also fulfil their loan obligations to international banks, just as customers have to fulfil their obligations to Australian banks. Australian banks taking loans from international banks could pass on the increased borrowing rates to their customers. Thus, higher interest rates in the US could mean higher interest rates in Australia.

The same can be applied to other economies that are borrowers from US banks. With higher interest rates in the US, investor demand tend to shift toward the US economy. As a result, there would be an increase in the demand for the US dollar, which will ultimately raise its value. This appreciation of the US dollar would be of huge significance to international markets. Consequently, all related currencies tend to see a jump in value, contributing further to global inflation.

What can be expected from the RBA?

The expectations for the next interest rate hike by the RBA are higher than the expectations built over previous months. The June rate hike of 50 basis points has altered the market expectations significantly. Experts largely expect the RBA to increase the cash rate by another 0.50% in the July meeting to 1.35%.

Central banks are expected to conduct steeper interest hikes in the early stages of their tightening cycle. Thus, the larger-than-expected rate hike of June has urged economists to believe that a similar hike might be on the way.

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However, the RBA is most likely to continue its tightening streak from thereon. Some experts believe that an even faster pace of tightening might be visible later this year. Additionally, speculations are rife that the Australian economy would be able to absorb this rate hike smoothly, as households have a solid savings backup to help them.

Alternatively, the present conditions of households reveal a different story. Most mortgage-paying Australians are finding it hard to manage the rising costs of living alongside hefty monthly repayments. The shift to higher interest rates may not be as smooth as expected. One can say that the economy is currently in a transition stage and needs time to adjust.

ALSO READ: Is Australian economy facing a wage-price spiral? 


 


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