Does the Reserve Bank's recent interest rate hikes ignore a much larger issue?

The Reserve Bank of Australia recently raised interest rates for the first time in almost three years in an effort to cool inflation and reign in spending. While this move is welcome news for Australians seeking a financial foothold, it looks to be just a bandaid on what may well prove to be a much more complex issue – one that has been hovering around our economy for some time now. In this post, we’ll examine how rising costs of living have made life more expensive than ever before while household incomes remain largely stagnant, and ask whether the RBA’s increased interest rates are enough to tackle these underlying issues of bad credit plaguing Australian households today? 

Last year, Australian interest rates rose significantly as the Reserve Bank of Australia (RBA) made a determined effort to rein in high inflation and ensure that it did not cause damage to the nation.

The bank’s swift decision to raise the cash rate by 3 percentage points in 2022 was one of its most aggressive monetary tightening cycles ever, second only to 1994 when it increased interest rates by 2.75 percent over a 5-month period.

Given the possibility of further interest rate raises projected for 2023, and Australian bank accounts already reeling from last year’s hikes, it is essential to take a moment to ponder if raising rates is truly the solution for inflation or are we overlooking an even bigger issue?

The rising cost of living

Inflation in Australia has climbed to a 30-year high, with the annual Consumer Price Index (CPI) reaching 7.8% as of December 2022 — meaning essentials like groceries, petrol and housing have become more expensive while our savings shrink in value. How did we reach this point? The answer lies within several economic factors such as supply and demand, but it’s nothing short of concerning when reflecting on how many Australians are feeling the effects of inflation today.

When the demand for a good or service surpasses its supply, prices will rise accordingly, making it impossible for people who cannot afford such costs to obtain these goods and services. However, if this high pricing persists long enough, then those in charge are expecting either that supply will expand to meet consumer needs or the increased cost of certain items will reduce overall demand until equilibrium is eventually attained. 

On the contrary, when goods exceed demand, prices typically drop to entice people into buying. Eventually this should balance out supply and demand until they reach equilibrium.

The RBA’s mission is to keep Australia’s inflation rate in the range of 2-3%, so that our economy can prosper while enabling everyday Australians to purchase necessary goods and services.

Supply chain problems

The inflation equation, both domestically and internationally, has been impacted by the COVID-19 pandemic, Russia’s incursion into Ukraine as well as increasing climate volatility; all of which are outside the authority of monetary authorities such as Australia’s Reserve Bank.

A recent survey conducted by the Australian Bureau of Statistics in February 2022 determined that 88% of supply chain difficulties for businesses were largely due to delivery delays, both domestically and overseas. As well as this, 80% experienced constraints on their sources while 75% saw a surge in prices with higher transportation expenses included. 

Despite the majority of COVID-19 obstructions and regulations having been lifted, supply chain disruptions remain present with few indications of improvement. In a study conducted by the AI Group, it was revealed that:

• In 2022, the number of businesses dealing with supply chain interruptions jumped 13%, amounting to nearly four out of every five businesses.
• Despite the tumultuous times, the proportion of businesses experiencing major interruptions remained firm (growing from 29% to 31%).
• The amount of businesses experiencing moderate disruptions skyrocketed by 11%, and now nearly half (48%) are affected.
• In 2022, a mere nine percent of businesses stated that their supply chains had improved.

Should these and other supply problems not be solved, they could potentially drive up inflation in both Australia and internationally.

How do interest rates play a role?

Central banks generally have limited control over the supply of various goods and services, so they concentrate on managing demand-side inflation by adjusting financial tools – particularly interest rates. By raising these rates, central banks can throttle consumer demand which has an immediate effect on tempering rising prices.

Despite the potential to reduce inflation, increasing the national cash rate (which Australian banks use to lend each other money in order to provide financial services) could harm economic growth and push up unemployment. Consequently, this goes against the RBA’s goal of strong economic performance.

Unfortunately, although raising interest rates is beneficial for stabilising the economy, it only works to suppress demand as people have less money available from loans and mortgages. However, this remains a viable strategy used by the RBA and if they chose not to use this approach it would be considered irresponsible.

If the RBA had heeded the warning signs and acted sooner to prevent inflation from escalating, they would not be in a precarious position where their window of opportunity for a “soft landing” is closing fast. Additionally, people are on heightened alert about what move will come next as it becomes increasingly likely that mistakes may occur due to their delay in taking action.

The bottom line

Despite the Reserve Bank of Australia’s (RBA) prediction that inflation would reach 8% by 2022, it only reached a maximum of 7.8%, in December quarter of 2022 – which is still an all-time high above RBA’s stated objective between 2 and 3%. Taking into consideration the strong tone set by RBA to reduce Australian inflation with whatever measures necessary, we can expect to see more hikes this year on cash rates.

If Australia hiked its interest rates too harshly and hastily, it could lead to an astonishing rise in the cost of living. Because of this, more Australians may struggle with their mortgages or be forced to sell their homes. Not only would homeowners lose out on a source of wealth and equity but they’d also have no secure place during the already severe rental crisis–ultimately resulting in drastic repercussions for housing as well as our country’s economy.

Supply chain and geographical issues may be causing even more disruption to Australia’s inflation than the RBA is suggesting, yet oversimplifying this dilemma isn’t helping anyone. If this is indeed a key factor driving up prices in Australia, perhaps it’s time for the Reserve Bank of Australia to halt raising interest rates and enact policies that encourage governments and businesses alike to tackle these underlying problems head-on. 

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