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RBA rate increase: Inflation caused by energy, rent and immigration


It feels like Groundhog Day for Australian mortgage holders, with the Reserve Bank of Australia (RBA) twisting the knife further on Tuesday with a further 25 basis point increase in the official cash rate (OCR) to 4.10 percent.

The move took the OCR to its highest level since April 2012 and represents the strongest increase in the country’s history:

In his statement accompanying the decision, Governor Phil Lowe noted that “inflation in Australia has passed its peak but, at 7 percent, is still too high and will take some time to get back into target range”.

“This further increase in interest rates is designed to build greater confidence that inflation will return to target within a reasonable time frame,” he said.

Governor Lowe warned that recent data indicated “that upside risks to the inflation outlook have increased and the council has responded”, in particular “while goods inflation is slowing down, services price inflation is still very high and proving to be very persistent abroad”.

Governor Lowe also noted that “further monetary policy tightening may be necessary to ensure inflation returns to target within a reasonable timeframe, but that will depend on how the economy and inflation evolve.”

Before concluding his statement with “the Council remains resolute in its determination to bring inflation back to target and will do whatever is necessary to achieve it”.

Feel sorry for the mortgagee

Once the rate hike is fully passed on by lenders, Australian variable rate mortgage holders will pay about 50 percent more in monthly repayments than they did in April 2022, just before the first RBA hike.

There are also about 500,000 fixed rate mortgages due in the rest of this year that will reset from ultra cheap rates of about 2 percent to rates of about 6 percent:

In turn, average mortgage rates across Australia will continue to rise even without further official rate hikes from the RBA.

So said David Bassanese, chief economist of Betashares The Australian in April that “the higher-than-usual maturity of fixed-rate mortgages over the next two years will result in a de facto policy tightening (at least for the mortgage industry) equivalent to about a third of the policy tightening already observed over the past year”.

That’s the equivalent of at least 1 percent of interest rate hikes remaining to be passed on to mortgage holders once the fixed-rate mortgage reset runs its course.

The impact of the fixed rate reset is illustrated in the following chart from the April RBA Financial Stability Review:

It shows that planned mortgage payments will rise to a historically high share of household income in 2024.

However, this analysis was based on an OCR of 3.60 percent, which is 0.50 basis points lower than the current level.

That’s why the situation is even worse now that Australian mortgage holders will soon have to spend a record share of their income on loan repayments.

How much worse will it get?

Forget the hoopla about the Fair Work Commission’s decision to grant a 5.75 percent pay rise to 20 percent of the workforce, which in real terms amounts to a pay cut.

The main inflation challenges facing the RBA come from two sources largely beyond its control: rents and energy.

Residential rents are the largest component of the consumer price index (CPI), comprising about 6 percent of the CPI basket.

During the Senate estimates hearing last week, Governor Lowe warned that rental housing growth is expected to reach a three-decade high, which will continue to fuel inflation.

He notes that the rent measure used in the CPI is currently growing by about 6 percent.

However, it is accelerating rapidly due to vacancy rates and is likely to reach 10 percent, which would be the highest rate since June 1989.

Lowe also warned that rental inflation would remain high for a long time as Australia’s population is growing strongly and demand for rent far exceeds supply.

Rather, the RBA’s aggressive rate hikes have contributed to the collapse in new housing construction, which will exacerbate rent deficits at a time of record immigration-driven growth:

Accordingly, residential rental prices will continue to rise, which will put upward pressure on the CPI and force the RBA to keep rates high for longer.

The other main point of inflationary pressure is energy prices, which fuel inflation across the economy.

Despite Australia being the world’s largest exporter of LNG – “the Saudi Arabia of gas” – consumers on the east coast are currently paying the highest gas prices in the world because our government has failed to implement a domestic gas reservation system.

Gas is the main determinant of electricity prices, and on July 1, electricity prices along the East Coast will rise by at least 25 percent, following a roughly similar increase last year.

This energy inflation will add 1.8 percent directly to the CPI over a year.

However, because energy costs feed through to everything else, inflation spillovers will be much higher because costs are passed on.

Energy costs can be as high as 3.5 percent on the CPI.

RBA attacks mismanaged immigration

At the Senate Estimates hearing last week, Governor Lowe warned that the supply side of the economy – business investment, infrastructure, housing and energy – was not keeping pace with record numbers of migrants arriving in Australia.

Last month’s federal budget projected an unprecedented 1.5 million net overseas migrants would arrive in Australia in the five years to 2026-2027, with a record 400,000 this financial year and 315,000 next year.

Governor Lowe warned Senate Estimates that “the amount of capital we have to work with on average is one of the drivers of productivity growth.”

“We need to increase the capital stock in line with the number of people in the country and that requires high levels of investment. And if we don’t, we’re going to have a hard time,” he said.

“If we get 2 percent more people in the country [this year]we need 2% more capital, and that requires investment by business and investment by government. I think solving the housing problem is the most important thing we can do. And then we need to build the transportation infrastructure to support that.”

“Are there 2 percent more homes? No,’ warned Lowe.

The above statement was a covert attempt at the federal government, which has chosen to force-feed Australia on a record-breaking migration without any plan to accommodate the extra people.

As a result, the amount of capital per worker decreases and rents rise, undermining productivity growth and fueling inflation.

The RBA is forced to raise interest rates, brutalizing a third of households with mortgages, without addressing the root causes.

The answers to Australia’s inflation problem lie with the federal government: moderate immigration and fix the energy market.

Leith van Onselen is co-founder of and Chief Economist at MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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Joanna Swanson

Joanna Swanson is Europe correspondent at the Thomson Reuters Foundation based in Brussels covering politics, culture, business, climate change, society, economies and inclusive tech. With specific focus in breaking news, she has covered some of the world's most significant stories.