On Tuesday the board of the Reserve Bank made it clear it wants higher unemployment and will keep raising interest rates until it achieves that aim.
The RBA raised the cash rate from 3.1% to 3.35%, for a total 325 basis points rises since April – the fastest since 1990:
https://www.datawrapper.de/_/XUJsR/
This is not quite as fast as the 390 basis points in 10 months that occurred from January 1988 but don’t worry, more rises are to come.
The scariest phrase for homeowners and anyone worried about the likelihood of a recession came in the final paragraph of the governor’s statement on Tuesday. It stated that “the Board expects that further increases in interest rates will be needed over the months ahead”.
Note the plural: “increases”.
This was a change from the December statement which noted “the Board expects to increase interest rates further over the period ahead.”
The financial markets noted the change.
On Monday investors were predicting the cash rate to peak at 3.7% by July; after the announcement that jumped to 3.93% by August:
https://www.datawrapper.de/_/hk4HC/
At least two more rate rises.
The good news? The market expects there will be two rate decreases between August 2023 and July 2024.
This is because the market expects the economy will slow so much the Reserve Bank will need to stimulate it. Why will it have slowed? Because the Reserve Bank is aiming to slow it.
That the bank wants higher unemployment is clear in the governor’s statement, which notes “the central forecast is for the unemployment rate to increase to 3.75% by the end of this year and 4.25% by mid-2025”.
Given the unemployment rate is 3.5%, that is the equivalent of an extra 105,000 unemployed.
The RBA wants this because it believes unemployment needs to rise to reduce inflation. This is despite the governor noting that “global factors explain much of this high inflation”.
He is certainly right about that. As a rule, the prices of items determined on the world market rise slower than domestic or “non-tradable” prices. But over the past year the opposite has occurred:
https://www.datawrapper.de/_/e3xjA/
So why is the RBA still increasing rates?
Because the bank also notes that “strong domestic demand is adding to the inflationary pressures in a number of areas of the economy”.
It wants to reduce this demand, which is code for raising unemployment.
And why?
Because, for all its talk about inflation, what the RBA is really worried about is wages.
Once again, despite no evidence that it is occurring, the RBA governor stated that “given the importance of avoiding a prices-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead”.
We know wages are not growing above inflation, let alone even at a level above 4.5% that would be inconsistent with the RBA’s target rate of 2%-3% inflation.
One reason that wages have not risen as fast as inflation is that wages are more aligned to the rise of service prices rather than goods (most of which are imported).
The price of goods has risen the fastest, but service prices are also now jumping. Market-sector service prices grew 6.3% in the year to December 2022, up from 4.8% in the year to September:
https://www.datawrapper.de/_/VuSU9/
Service prices, however, were pretty wild in the December quarter – especially when you recall that in the last three months of 2022, the cost of domestic holidays alone rose 13%, and that accounted for nearly a fifth of the total increase in inflation.
But if the “price-setting behaviour of firms” means that businesses use the cover of inflation to further raise prices and increase profits, the bank expects workers not to agitate for higher wages.
And while wages should keep rising faster, thus far the evidence is of them being very calm.
The latest data, for example, shows that in the last three months of 2022 the weighted average of enterprise bargaining agreements had annual wage growth of just 3.1%.
But the Reserve Bank is raising rates to slow the economy by making the cost of borrowing higher, which will reduce investment and also reduce the ability of mortgage owners to spend money, and thus increase unemployment – especially in the services sectors.
That will happen. Let us not pretend interest rate rises do not slow the economy.
The problem is the Reserve Bank has little faith in their power.
In December I noted that interest rate rises “actually take a while to affect all mortgage holders”. Since then, the RBA has stated that “the Board recognises that monetary policy operates with a lag and that the full effect of the cumulative increase in interest rates is yet to be felt in mortgage payments”.
By the end of last year the average rate of all mortgages had only risen 193 basis points, compared with the actual 300 basis points rise in the cash rate:
https://www.datawrapper.de/_/P7nMp/
That leaves more than a third of the rate rises still to fully flow through to all mortgage holders.
Given the average repayments on a $500,000 home loan have already risen from $2,010 to $2,542 a month, that suggests they will rise around another $400 a month yet, just to take into account all the rate rises thus far:
https://www.datawrapper.de/_/4P5Xb/
That would be around a 45% increase in mortgage payments and yet still the RBA does not think that is enough and will keep raising rates.
Given it admits that “there is uncertainty around the timing and extent of the expected slowdown in household spending”, we had all better hope the slowdown does not happen before the full effect of the rate rises thus far occurs.
Greg Jericho is a Guardian columnist and policy director at the Centre for Future Work
