Interest Rates: Why RBA Raises Spot Rates Amid Recession Fears And Falling Home Prices

Interest rates are rising and fears are growing that a recession is imminent. So why is the RBA doing this to us?

As Australia recovers from the Reserve Bank’s latest double rate hike, fears are mounting that the economy is in serious trouble, with house prices collapsing and even a recession on the horizon.

It all started in May, when the RBA announced its first official rate hike since 2010, raising the spot rate by 25 basis points to 0.35 percent.

A month later, the RBA once again sent homeowners chills with a “super-big” rate hike of 50 basis points, followed by another 50 basis point jump this week, with the spot rate now standing at 1.35 percent.

But now that the shock has worn off and Aussies are faced with the reality of seemingly endless rate hikes to come, attention is turned to why the RBA is doing this to us – especially given the risks that appear to be so alarmingly high.

recession fears

We’ve been hearing for months that rising interest rates could weigh on house prices, with the RBA estimating in its latest Financial Stability Review that a 200 basis point increase in interest rates from current levels would lower real house prices by about 15 percent over a two-year period. ”.

At the same time, consumer confidence has fallen to its lowest level since the recession of the 1990s, save for one spike at the start of the pandemic, with some fearing that anxious families with less cash in their pockets will simply stop spending altogether, which could help to push the country into recession.

So why is the RBA acting so aggressively?

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Economist Shane Oliver told news.com.au that the RBA was weighing the risks of not doing enough and letting inflation spiral out of control, or raising interest rates and causing short-term pain to a worse disaster. to prevent.

“They are raising rates because inflation is high and seems to have worsened since they started in May [raising rates], especially with rising electricity prices. Then they predicted inflation would peak at 6 percent, and now they’ve adjusted it to 7 percent,” he said.

That led to more aggressive hikes from June and continuing into July as they worry more that the longer inflation stays high, the longer people will expect it to stay high, which is built into wage and price settings and ends in a 1970s-style Wage Price Spiral.

“They are tightening more aggressively because there is a more serious inflation problem.”

He said that if inflation slowed, the RBA could stop raising rates earlier than expected, ahead of the forecasted peak of more than 3 percent.

dr. Oliver acknowledged that it was confusing for many Aussies to watch the RBA continue to raise interest rates amid mounting fears of a recession and falling house prices.

He pointed to recent comments from US Federal Reserve chain Jerome Powell, who said the central bank would “tolerate” a recession to curb inflation, and said the RBA is all about balancing risk.

“If you look at the 1970s, there were several recessions and stagflation with very weak economic growth, rising high unemployment and high inflation, and the consensus from that period was that high inflation was pretty bad for the economy, jobs and investment markets, ” he said.

“You could make the argument that it’s better to go high and cause a little pain now, even if it causes a short-term recession, to avoid a repeat of the 1970s.

“If inflation spirals out of control, it will lead to worse outcomes than just one recession, so in the longer run, the country will benefit from it,” he said. “It sounds a bit heartless because recessions increase unemployment, but if inflation gets out of hand, unemployment could be higher for a longer period of time.”

However, he acknowledged that the RBA was taking a risk.

“It’s like tapping the brake of a car, if you keep tapping, it eventually stops, and the economy is the same — if you keep raising rates, the economy eventually stops, and that’s why people worry about it,” he said.

“But in the 1970s, there was a Misery Index that assessed inflation and unemployment and found that inflation was just as hated as unemployment – ​​unemployment only affects the unemployed, but inflation affects everyone.”

dr. Oliver said consumer confidence had recently fallen to levels usually associated with a recession, with the rising cost of living already reducing household purchasing power as our wages decline.

“Unemployment sounds worse [than inflation]but for the average person who still has a job, you could argue that high inflation is a bigger problem because it means a drop in living standards, and central banks have to weigh all of that,” he said.

“The RBA weighs two evils…but they’re letting inflation spiral out of control, it’s the worst of both worlds – living standards are falling because you can’t spend more and unemployment is still high.”

Fellow economist Chris Richardson agreed that inflation was a “thief in the night” and that when prices moved quickly on a regular basis, it caused “all kinds of problems” for people from all walks of life, which is why the RBA fought it so much. hard against.

“Inflation is bad news for a lot of people – we really don’t want inflation to hang around, so the RBA has to steer the course between two paths, between going too fast and slowing the economy down too much, meaning unemployment disappears. up…or goes too slow, and inflation will hang and need to be throttled out of the economy,” he said.

“Going too slow now could mean higher yields linger longer – one risk is recession and the other is stagflation.

“The question is how much does the Australian economy need to slow down to ensure we’re not stuck with an ongoing problem?”

Read related topics:Cost of livingReserve bank

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