Interest Rate Rises, Wage Stagnation and Inflation: What’s Up With All of That?

By this point, you are probably aware that the Australian economy has spent some months in a chaotic torpor. You will, at some point since May 5, have heard mostly harried older men squawk cryptic phrases like “interest rate rises” and “wage stagnation” and “inflation”, but stop short of arming you with any of the tools needed to interpret them. 

Addressing the nation, these men generally have no intention to make themselves widely understood.

Turn your attention to the homepages of any number of news sites this week and you’ll see mention of a certain “RBA governor” “flagging” “further steps” on “interest rates”. You’ll see a flurry of “rates calculators” and analyses from columnists who sketch out a near future that sounds bad, even if only based on vibes. 

Bloomberg says “Australia Hikes by Half-Point for Third Month to Cool Prices”, which you think might suggest that prices are hot, and indeed need to be cooled, which can only be… bad? In the pages of the Financial Review, you can indulge in more of this stuff, sometimes for weeks on end. “Time up for Chalmers’ protestations of wasted decade,” reads the homepage, in amongst a smorgasbord of what appear to be economic obituaries.

Still, you wonder: what the fuck. 

Let’s start with Tuesday. At 2:30p.m. on the first Tuesday of every month—also known to select nerds as “rates day”—the Reserve Bank of Australia’s (RBA) board meets before handing down market-moving economic decisions. Namely, the “interest rate”. 

After that meeting draws to a close, the RBA—otherwise known as Australia’s “central bank”—issues a statement, explaining why it made whatever decision it announced, along with some amble on how it thinks the next few months will play out. Those remarks are made by Philip Lowe, the bank’s governor.

At the heart of why you’re reading this and, why, I guess, I wrote it, is that what Lowe announced on Tuesday will likely come to play a key role in much of the economic turmoil we’ll see in Australia in the not so distant future, if not—at the very least—how it’s discussed. 

WHAT IS THE INTEREST RATE AND WHAT HAPPENED TO IT

This week, Lowe announced that the RBA will increase the interest rate for the fourth month in a row, this time by 0.50 percent, after it was increased on May 5 for the first time in more than 18 months. (Stay with me). 

The interest rate, or the “cash rate”, essentially determines the rate at which banks and other institutions borrow money—a premium which is then passed on to businesses, and regular people like you and me, who might also want to borrow money. It’s the cost of borrowing money. 

For much of the pandemic, this rate was 0.10 percent, a record low and the closest proximity Australians have ever had to “free money”. 

The rate was driven down as low as it was to encourage swathes of Australians to take out loans at the height of the pandemic, to pump money into an economy that was suffering because people were losing jobs and saving whatever money they had. In basic terms: they wanted people to get spending through peak economic uncertainty. The central bank and monetary policy experts call this kind of thing a “stimulus” measure. It’s stimulating the economy by getting people to spend money (which, in many cases, they didn’t have in the first place). 

So why is the interest rate going back up?

Well, with all that cash sloshing around, overspending was bound to become a problem. And it has. Now, policy experts, including those at the RBA, say that overspending is contributing to inflation (more on that later). So, the thinking goes: by increasing the cash rate, you’re making it harder to borrow. And that, at least in theory, should make things less unaffordable, and drive down inflation.

Trying to slow inflation by making it more expensive to borrow money, experts say, is going to impact all corners of the economy, even if you aren’t among the thousands of Australians who took out loans at bottom dollar rates during the pandemic to buy a car, a house, a boat, or whatever. 

But let’s start with those people. In the short-term, they’re the ones who are going to suffer most—and some say they already are. Some experts are even predicting a bloodbath. 

In material terms, what they’re talking about are mortgage repayments. In Australia, the median property price over the last few years has hovered around $1 million. It’s probably safe to guess that a sizeable chunk of the loans taken out while the cash rate was at 0.10 percent were in the ballpark of $1 million. For those folks, monthly mortgage repayments have already become $1,000 more expensive every month since the RBA’s meeting in May, because as interest rates go up, so too does the rate at which loans are to be repaid. 

For the rest of us, the implications are just as real. 

Aside from those new home buyers who are, collectively, expected to default on billions of dollars worth of loans, rising interest rates are expected to be a handbrake on wages, will likely drive sweeping layoffs across the economy, and will eventually become a contributing factor to rising rents (which are already on a steep incline).

How, then, does the RBA plan to forge a path back to some semblance of normal? 

Without taking your hand and walking you to the edge of a cliff, the RBA governor would tell you, politely, that Tuesday’s rate rise was just the next step in the normalisation of monetary conditions in Australia. That’s code for trying to wean the nation off years of stimulus measures, which are now suspected to be making everything more expensive. 

In his monthly statement, he said: “The size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market.”

You never really know with him, though. For much of the pandemic, Lowe told the public a rate rise wouldn’t be on the cards until at least 2024. People took out loans with that advice, and have been hit with increases years earlier than they expected. Add that to the uncertainty seen in the global energy market (more on that later, too) and inflation forecast to rise from the 6.1 percent we’re seeing now to a peak of 7.75 percent (a lot) later this year, the bank’s future moves are “clouded in uncertainty”. 

But we can guess that as inflation continues to rise, so too will interest rates.

HOW DID WE GET HERE?

Let’s speed-round this, and look no further back than the pandemic. Despite widespread, mostly Trumpian denial, in March 2020 the lethal coronavirus started to make its way around the world. Millions died, millions more still could, and countless others are expected to live with the lasting impacts of long-COVID as far as we can see. 

Through the thick of the pandemic, you will remember, businesses closed and people were ordered to stay at home. Stock markets around the world tanked, leaving Australia’s Commonwealth and state governments to work together to co-fund unemployment benefits, small business safety nets, and corporate support (remember JobKeeper?), which was unsurprisingly funnelled into executive paychecks.

Pouring cash directly into the hands of Australians was one part of the Commonwealth’s stimulus strategy through the pandemic. The other was lowering interest rates (which we went over earlier). Corporations and everyday people had virtually no barriers to borrowing money. People trapped at home, unhappy with their houses and apartments, could now take out a loan for the renovations they’d long been putting off, at pretty much no cost. People could now enter the housing market without having to hand over as much of a deposit. Australians were being encouraged to go all in. 

But Australia, like many other countries around the world, has very limited housing stock. Demand, only one year into the pandemic, was far outpacing supply. As a result, house prices skyrocketed. Newspapers were running out of ways to describe it. Was it “white hot”? Was it “frothy”? Maybe it was “red hot”, or house prices were simply “running away”. Buyers had new access to cash and were flooding a market already riddled with scarcity.

We started to see this play out in other corners of the economy, too. 

The used car market was swamped with would-be buyers and microchip prices ballooned because nobody could find them. Everyone was glamming up their home offices. We saw a massive timber shortage, thanks to all those stuck at home trying to get renovations done, which then drove up construction costs. Then there was the Suez Canal fracas, which caused a humdrum of other supply-side chaos, maybe not directly linked to the pandemic but it nevertheless made things worse. (Nothing quite like a massive ship blocking one of the world’s busiest trade routes to light a fire under already strained supply chains, in the middle of a once in a lifetime pandemic).

While certain parts of the consumer economy were being suffocated with demand it couldn’t meet, other parts were unable to take advantage of this renewed appetite for spending at all. Bars, hotels, RSLs and restaurants were shuttered, for a long time. So, there was all this cash being spent, fewer goods available to spend it on, and fewer places to find them at.

The final variable worth considering here is Russia’s invasion of Ukraine. 

As a result of its mass offensive to the West, Russia was slapped with sanctions by pretty much every major economy in the world, bar China. That, in effect, meant that Russia couldn’t import or export goods from any major producers. But it also meant that Russia, one of the biggest global providers of oil and natural gas in the world, stopped supplying the countries that sanctioned it. That drove energy prices up, which in turn drove shipping prices up.

Prices went up, because sellers knew buyers had no choice, and could shoulder the costs because the costs of borrowing money were at record lows. This is broadly called “inflation”. 

The United States was among the first to feel the pinch of inflation last year, when prices soared by the highest rate seen in nearly four decades. American families were left with little to no purchasing power, and the Federal Reserve—their equivalent to the RBA—was tipped to embark on a similar strategy to get it under control, to what is now being seen in Australia.

At the root of the inflationary pressures seen in the US was shelter and the used car market. Nobody wanted to be on public transport, because America’s COVID-19 risk mitigation strategies verged on pointless. So, everyone needed cars. This, along with a lot of what we also saw in Australia—rising timber prices, wages, and a few other factors too complex to get into here—drove inflation in the US up to 7 percent in January this year. 

By comparison, Australia’s headline inflation rate is hovering around 6.1 percent, but is set to eclipse even the most alarming inflation forecasts bouncing around this time last year, when 7 percent by the end of 2022 was considered “bad”.

WHAT ARE THE BEST IN THE BUSINESS SAYING AND SHOULD I ACTUALLY BE WORRIED?

Here’s what our new federal treasurer, Jim Chalmers, had to say about the state of play during question time in parliament on Tuesday: “Australians knew that this was coming, but it won’t make it any easier for them to handle.

“Now, obviously, higher interest rates primarily affect mortgage holders but there is a broader economic impact as well because there is an impact on economic growth which I talked about in a ministerial statement last week. There is also an impact on the budget. It means that the trillion dollars of debt the previous government left us gets even more expensive for us to service.”

A new combination of higher borrowing costs, slowly falling property prices, and the rising cost of living in Australia has started to drum up new talk of a possible “recession” (a term that means the economy has seen negative growth, or simply gone backwards, for two quarters in a row). There is a 25 percent chance of that happening, according to Goldman Sachs, in which case it’s predicted the RBA will start winding rates back down again to bring us closer to square one.

While inflation is currently expected to peak at 7.75 percent, the RBA has signalled it won’t stop upping interest rates until that rate, among other things, is within its “target range” of 2–3 percent. We don’t really have any clues when that’ll happen. But there are already some optimistic signs that the bank’s strategy is working. Retail sales are slowing, and internal data from major banks, according to Bloomberg, shows that people are just spending less. 

Some economists also think that the most jarring interest rate rises, like the 50-basis-point increase we saw this week, are now behind us, and that the bank will take a smaller, more incremental approach to rate rises from here on in. 

But really, it’s anyone’s guess. 

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