Is an interest rate hike on the way in Australia?

Highlights

• The Australian economy seems to be well beyond the stage where a monetary stimulus is needed.
• Extremely accommodating policy measures does not seem to fit well in the current high inflation environment.
• Some experts predict that the interest rates will rise this year.

Experts have long been of the view that existing inflationary pressures will lead to an earlier than expected interest rate hike in Australia. Soaring employment numbers and rising inflation signify that the economy is well beyond the stage where a monetary stimulus is needed. Thus, experts are anticipating a fundamental shift in policy in the coming months.  

However, the Omicron wave is a looming concern, which has been causing subdued demand in the country to some extent. This has been more pronounced in the new year as consumer confidence drastically slipped in the first few weeks of January 2022 after a period of incredible spending during the holidays.

Thus, it remains to be seen how soon the central bank tightens its monetary policy measures to prevent rising inflation as risks to economic growth cannot be neglected.

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The pressing need for policy action

The Reserve Bank of Australia (RBA) has so far been cryptic around the topic of an interest rate hike. This has long been a cause of concern, with inflation moving out of control. As per recent data from the Australian Bureau of Statistics, Australia's Consumer Price Index rose to 3.5% for the full 2021 year in the December quarter.

Given the recent surge in prices, experts have become fearful of the extremely accommodating policy measures that do not seem to fit well in the current high inflation environment. Meanwhile, the existing financial scenario seems highly favourable for borrowers, with surging inflation in the backdrop creating a risky environment.

While prices are rising, real interest rates have declined, presenting an even more pressing scenario for the RBA to increase the cash rate. Despite any news from the central bank, experts predict that rates will rise this year.

Westpac Banking Corp (ASX: WBC) forecasters believe that the RBA might embrace a rate hike by August this year. Meanwhile, experts at National Australia Bank Limited (ASX:NAB) expect the central bank to increase interest rates in November 2022, with follow up hikes in December and February 2023.

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The Phillips curve conundrum

The Phillips curve is one of the best depictions of the harsher realities facing policymakers in the Australian economy. The curve essentially highlights the phenomenon that only one problem can be solved at a time out of high inflation and high unemployment.

The Phillips curve theory can be applied quite seamlessly in the current context of rising prices and slow wages growth. The Reserve Bank knows that the labour market will have to undergo some tightening for inflation to be brought under control. As per the theory, a potential decline in inflation is more likely to be accompanied by high unemployment.

However, it seems that RBA is relying too heavily on this theory as it awaits further increases in wages. The central bank has kept wages growth as the threshold to raise interest rates. But the wages in Australia have not really grown at par with the rising price levels.

In fact, wages growth has largely been slow and less than ideal in the Australian economy. This is precisely what seems to be refraining the RBA from raising interest rates. However, the red-hot inflation has made the scenario increasingly inhospitable for low interest rates.

Bottom Line

Perhaps a more efficient strategy could be focusing solely on wages growth without putting inflation levels at stake. The central bank can rely on the natural progress seen in the economy as businesses returned to life after lockdowns were removed.

Amidst this improvement, the rising demand for labour has offered more bargaining power to workers, putting increased pressure on companies to provide higher wages. However, the upcoming policy meetings are expected to shed further light on the central bank’s plans for monetary policy adjustments.

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