Interest rates

What rising inflation means for interest rates and the cost of living – and it’s not good news

It was a dark old day on the economic front.

The day started rather badly following another big fall on Wall Street overnight.

For global investors, there is cause for concern: rising inflation and what that means for interest rates, geopolitical instability and, of course, the pandemic.

After heavy falls earlier this week, the Australian stock market fell again today.

The concern closer to home is that the latest COVID-19 outbreak in China will hurt China’s economic growth and that’s bad news for local miners.

“The market is signaling the risks of a slowdown in the Chinese economy due to the COVID shutdowns and of course the risk of inflation leading to central bank interest rate tightening,” the analyst said. Henry Jennings stock market.

The stock market is screaming a message right now: the economy is not OK.

Before exploring this, there is an urgent problem – a further increase in the cost of living.

Interest rates on the move

We have seen a significant development today which means that a May rate hike from the Reserve Bank is now a distinct possibility.

On numerous occasions over the past two years, the RBA has insisted that it must see underlying inflation remain within the target range of 2-3% to justify an increase in the target rate.

That, he said, would likely depend on a sustained and material acceleration in wage growth.

Fast forward to now and the inflation rate – as measured by the March quarter CPI – jumped to over 5% (with no significant increase in wages).

Economists have collapsed to repost their thoughts on what this means for monetary policy.

“Based on today’s very strong first quarter CPI data, the NAB now expects the RBA to raise the cash rate target by 15 basis points at the meeting of the board of directors of May next week,” notes NAB Chief Economist Alan Oster.

“Further increases of 25 basis points in June, July, August and November will bring the target rate to 1.25% by the end of the year.”

Several other economists have made similar calls.

The bottom line? Borrowers with fixed rate loans have been experiencing higher interest rates for some time, but for now it is those with variable rates who will pay higher monthly bills.

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What are the damages?

Those who recently took out fixed-rate mortgages, depending on the term, will be paying hundreds of dollars more a year on their repayments — especially those who had to refinance after being locked in for two years at the start of the pandemic.

“And over the next year many fixed rate mortgage borrowers will move from rates of 2% to around 4% which, combined with the negative wealth effect from the likely decline in house prices , will start doing some of the work of the RBA.” says AMP chief economist Shane Oliver.

Household budgets for variable rate borrowers are about to be hit.

RateCity has applied Westpac’s updated RBA rate hike forecast to determine how much existing floating rate borrowers will be slowed down.

This forecast sees the RBA raise the cash rate by 0.40% in June and reach 2% by May next year.

For a variable rate borrower with $500,000 to pay, their monthly repayments could increase by $513 by May 2023, if the cash rate hits 2% as expected.

If the RBA raises the cash rate target by 0.15 percentage points next week, your monthly repayment will increase to $2,389, up $39.

Many households still have large post-pandemic cash reserves and some are well ahead of their mortgage payments, so this doesn’t look like some sort of housing market slump, but it should slow economic growth.

“The explosion in inflation suggests that Australia is now starting to face the same risks as in various other countries, that is, inflation expectations will spin out of control, locking in above-average inflation. objective and making it even more difficult to bring inflation down,” said AMP chief economist Shane Oliver.

Big economic risks

Investors watch all this and mourn.

Let’s be realistic for a moment: the pandemic is alive and well and there is a real chance that the Chinese economy will be hit again, which is negative for the Australian resources sector and of course the budgetary result, which is already in structural deficit.

We also now have an inflation breakout. The “genius” of inflation is out of the bottle. Rising business costs are now well and truly being passed on to consumers, and as shoppers spend their pandemic reserves, demand-driven inflation is also starting to rise.

What economists would like to see now, as the government pulls back from its massive pandemic stimulus package, is for businesses and consumers to shoulder more of the burden in terms of economic growth. This will be a greater challenge in a world where borrowing costs continue to rise.

Add to that, there still seems very little evidence that anyone’s salary will increase significantly in the short term.

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Do you see where this leads?

The Reserve Bank is going to be forced to take advantage of the brakes of an economy that is just getting by and facing significant headwinds.

It will also attempt to contain a spike in inflation that is not largely driven by higher wages and extremely strong consumer demand.

It is driven by pandemic supply constraints and geopolitical instability.

In other words, the cost of getting produce from the factory or farm has skyrocketed and the price of gasoline remains painfully higher for motorists as a direct result of the war in Ukraine.

“Australia is not immune to international pressures that drive up inflation,” Treasurer Josh Frydenberg said.

“Today’s inflation figures remind Australians that we live in a complex and volatile economic environment.”

You can see a scenario unfolding in which the household budget is simply cut further, and the response is to fund this by drawing more from savings – savings that could have been spent on more discretionary purchases.

We really didn’t need this surge of inflation. The stock market simply reflects the extent of the damage it predicts.

And as Henry Jennings says, there could be other downfalls.

“The market is shifted from 7600 to 7279 [points]so around 4.2%…7000 should have good support but that’s due to a rebound and then maybe a drop as we enter the May-September doldrums,” he said. declared.

It’s market jargon because there are dark clouds ahead of us.

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