Central banks across the globe find themselves in a challenging predicament, and our own Reserve Bank of Australia (RBA) faces a particularly delicate situation. In Australia, an intricate interplay of demographics and home ownership dynamics creates a paradox where those who bear the brunt of rising interest rates are not the ones fuelling the inflationary fire through their spending habits.
Unlike mortgagees in the United States, Australian mortgage holders (albeit for good reason) lack the luxury of securing 30-year fixed-rate mortgages, leaving them vulnerable to immediate shocks when interest rates surge. And they have most certainly been doing that.
This combination of factors leads to a disconcerting cycle. Affluent and cashed-up baby boomers and mortgage-free Generation X homeowners, shielded from the RBA’s rate hikes, continue to drive expenditure, exerting upward pressure on prices. Paradoxically, this compels the RBA to further raise interest rates, inflicting hardships on those with mortgages, individuals who, by necessity, have already curtailed their spending.
And their plot is made worse by the heightened interest rates which simultaneously produce even greater returns on cash and term deposits, bolstering the purchasing power of those boomers and gen-Xers unburdened by mortgages.
The undeniable truth is that the repercussions of higher interest rates and inflation do not afflict all Australians evenly. As I reported previously, recent data from the Commonwealth Bank, drawn from a staggering 7.8 million customers, confirms that individuals aged over 65 increased their spending by six per cent in the year ending on September 30, surpassing the rate of inflation. Meanwhile, those under 40 reduced their expenditures, with the age group between 25 and 29 showing the most significant decline – a particularly poignant statistic given the prevailing inflation rate of around five per cent.
We have contended that the pain borne by those directly impacted by higher interest rates may persist. Contrary to expectations of declining interest rates, we might find ourselves looking back in a year’s time and discovering that rates have remained stubbornly stable and high.
And the probability of that scenario just gained a whole lot more traction after the Reserve Bank Governor Michele Bullock cast a gloomy shadow over the future at the Australian Business Economist dinner in Sydney on Wednesday 22 November.
Bullock noted Australia’s inflation problem has taken on a predominantly domestic character and could demand another two years to rein in. Bullock underscored the necessity for the RBA to utilize its somewhat “blunt tool” of interest rates to wrestle inflation under control, in the collective interest of all Australians.
Against the backdrop of surging prices for goods and services and highlighting a demand-supply imbalance in the economy, Bullock highlighted that everything from haircuts to dental care and dining out has experienced substantial price hikes. Bullock noted that, initially, Australia’s inflation was spurred by supply chain disruptions during the pandemic and the conflict in Ukraine. The gradual resolution of these influences has seen inflation subside from eight per cent to 5.5 per cent over three quarters.
The new challenge lies in inflation that is increasingly homegrown, and domestically demand-driven. In this context, Bullock anticipates it will take approximately two years to steer inflation back within the central bank’s target range of two to three per cent, noting it will be particularly painful for those on modest incomes. The central objective is to harmonize aggregate demand and supply, restraining demand sufficiently to achieve the target while nurturing employment growth.
The RBA has been rapidly raising interest rates since May last year, and most recently pushed the cash rate up by another 25 basis points to 4.35 per cent in November.
Without specifically calling out boomers and Xers, Bullock acknowledged the wide difference in how these rate increases are experienced by diverse cohorts in the population. Bullock also acknowledged the primary instrument at the RBA’s disposal, interest rates, is a relatively blunt tool but reinforced the RBA’s overarching goals, which are directed at the broader economy and the collective welfare of all Australians.
Already, charities are reportedly grappling with unprecedented demands as financial pressures intensify, and looking ahead, 2024 seems poised to inflict greater challenges on at least the one thirds of Australian households who have a mortgage. Anecdotally, car dealers are experiencing a pile up of stock on their lots as big-ticket items are the first to be cut when excess savings vaporise. That rationalisation of spending will continue to trickle down to lower-priced items as the longer rates remain elevated.