We expect the RBA to raise rates quickly in Q3 and then slow the pace of rate hikes in Q4 and H1 2023
B2B firms should expect greater price sensitivity among customers that rely on credit as a major source of financing. Firms in industries that are already struggling with high input and labor costs, such as mining and construction, will come under greater margin pressure over the next 12 months. SMEs, particularly in the service sector, may also see a decline in sentiment and a strain on budgets, as these groups racked up large debts over the pandemic to stay afloat.
B2C firms should expect rising interest rates to weigh on new homeowners, particularly in suburbs around big cities, who bought houses over the last two years with attractive interest rates. Hikes by the RBA (along with rising levels of inflation) will also show up in H2 2022 in the form of lower consumer confidence. However, the impact of higher rates will have a muted impact on overall spending levels, as recent homeowners make up a small portion of the population. Furthermore, most Australian households have built up substantial savings over the past two years to draw on.
Overview
The Reserve Bank of Australia (RBA) raised the country’s official cash rate by 50 basis points on June 7, bringing its benchmark interest rate to 0.85%. This is Australia’s largest interest rate hike since February 2000, and it comes on the heels of a 25-basis point rate increase in May.
Our View
Last week’s above-expectation rate hike made it clear that the number-one priority for the RBA is to contain rising inflationary pressure in the Australian economy. Specifically, the RBA will aggressively defend its target of keeping underlying inflation between 2–3%. Underlying inflation—which ignores one-off price movements—grew by 3.7% YOY in Q1 2022, while headline inflation rose by 5.1% YOY. Both figures will continue to rise in Q2 and Q3, as price increases flow through the economy. Underlying inflation is not expected to return to the acceptable band of 2–3% this year and, as a result, the RBA will continue to raise rates through the rest of 2022 and into the first half of 2023.
Under our base-case expectation, the RBA will raise rates rapidly next quarter, as Australia faces another inflation shock once Q2 2022’s figures are released, showing underlying inflation to be well above the 2–3% range. The central bank will also look to raise rates quickly in the short term to prevent high inflation expectations from becoming anchored in the minds of households and businesses. After that, in Q4 2022 and beyond, the RBA will lower the frequency and magnitude of its rate hikes to allow the economy to adjust to higher interest rates, and to prevent households with high debt levels from coming under severe budgetary pressure.
Under our escalation scenario, the RBA will put greater emphasis on inflation expectations held by Australian consumers. Here, consumer confidence will fall deeper into pessimistic territory due to rising price pressure, which will be reinforced by high inflation figures in subsequent quarters. The RBA, in response, will continue to raise rates rapidly through H1 2023 to curb inflation quickly and strongly signal to households that major steps are being taken to ensure that inflation does not persist indefinitely.
Finally, under our pull-back scenario, the RBA will not pass any more 50-basis-point hikes, hoping that June’s rate increase would be enough to assuage the concerns of consumers. More importantly, the RBA will also consider downstream effects on the country’s housing market, which boomed over the pandemic as new homeowners took advantage of low interest rates. Raising interest rates too quickly would put mortgage holders under severe pressure and raise the risk of defaults, so the RBA will adopt a more moderate tightening schedule.
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