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  • Writer's pictureShaun Brien

Rising Interest, Rising Costs

2022 has taken a fairly wild turn when it comes to our economic indicators and monetary policy.

At the time of writing our domestic macroeconomic goals are currently sitting at:

  • Inflation - 6.1%

  • Real GDP Growth - 3.3%

  • Unemployment - 3.5%

An inflation rate of 6.1% is the highest prices have risen in decades and it has been driven largely by increases in the cost of fuel and groceries.

As the RBA first and first most uses monetary policy to tackle inflation they have recently increased the cash rate on 3 separate occasions bringing the cash rate up from a historic low of 0.1% up to 1.35% (with a likelihood of it rising again in a few days time). In Australia we have an incredibly high household indebtedness ratio (meaning households owe much more than they earn) which means that as the cash rate increases, banks pass on this increase through higher interest rates. This then means that households with variable rate home loans face higher interest repayments and are left with less discretionary income. Then then leads to reductions in private consumption and investment spending from businesses with acquired debt and therefore aggregate demand decreases overall.

Will this be enough to curb demand inflationary pressures? Well, it's debatable at the moment because a sizeable proportion of our inflation has been caused by supply side issues (natural disasters, wars, labour shortages etc.) and while prices have been rising, businesses have also been posting record profits which seems to imply that businesses are passing on rising costs at a far higher rate than is needed. At the same time as all of this, wage growth has been incredibly stagnant outside of the 5.2% increase in the minimum wage. Historically it has been argued that low unemployment rates will increase pressure on wages but the current 3.5% unemployment rate with weak wage growth is proving quite the opposite.

Regardless, the reduction in discretionary income from households is going to slow aggregate demand, with economic growth slated to fall to 2.5% in 2023/24, house prices expected to fall by up to 15% and more flow on effects that should ease inflationary pressures in some way.

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