Reserve Bank signals earlier than expected rate increases possible

The Reserve Bank formally dropping one of the support measures for the economy introduced following the COVID-19 crisis.

This signals an improvement in the economic outlook and increased likelihood, but not yet an expectation, that interest rates will start to increase earlier than the previous guidance of 2024.

So what’s changed?

The RBA has formally dropped its yield-curve control policy. This had the RBA buying bonds maturing in April 2024 until their yield hit 0.1%, to push down longer-term interest rates.

This follows the improvement in the economy and the earlier-than-expected progress towards their inflation target.

The RBA has left its other policy tools unchanged: the cash rate target remains at 0.1% and their QE bond buying program will continue (and will now include purchases of the bond maturing in April 2024, just without an explicit yield target).

This is the first indication from the RBA that rates may rise earlier than the 2024 guidance it has previously provided.

The RBA will continue to be led by the outcome of both wages growth and inflation as to when the cash rate will start to increase.  And they have emphasised patience: their upgraded forecasts, due to be released in full on Friday, only have inflation at 2.5% – in the middle of their target band – in late 2023.

This suggests cash rate increases are still some way off, and the RBA explicitly batted down suggestions the cash rate would change next year.

But it has signalled the upside surprises in the recovery following the COVID-19 recession have led to increased uncertainty about when conditions in the economy will warrant higher interest rates.

What does this mean for borrowers?

This change represents a slight tightening in financial conditions and increases the expectation that interest rates will increase within the next couple of years.

This means rates for longer-term fixed mortgages will continue to increase, but we are unlikely to see upward pressure on variable rate mortgages in the near term – particularly for owner-occupiers, for whom competition among lenders is strongest.

For existing borrowers, they may see higher interest rates, and increased repayments, earlier than they had expected. But the RBA is likely to increase rates slowly as we move out of a period of exceptionally low interest rates.

The other question is about lending standards and further possible macroprudential measures that restrict the flow of credit.

There was not much new information on that front on Tuesday, but Governor Lowe did welcome APRA’s increase in the interest rate buffer from 2.5 to 3 percentage points, but noted he did not have any concerns about deteriorating lending standards.

Further action here will depend on continued strong housing price growth and market activity by investors and highly indebted borrowers.

When will we hear more from the RBA?

The RBA will release it’s updated forecasts in its Statement on Monetary Policy on Friday, and the Governor will give a speech entitled “Recent Developments in the Domestic and Global Economies”, which will go into more detail on economic conditions in two weeks.

Expect to learn more about the RBA’s thinking on the evolution of wages and inflation and what that means for the outlook for interest rates.

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