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As the treasurer considers the review of the RBA that has just landed on his desk, the central bank has paused its most aggressive interest rate raising cycle in a generation, and warned the worst impact is still to come. By Mike Seccombe.

Inside the RBA’s latest rates decision

The governor of the Reserve Bank of Australia, Philip Lowe.

Credit: AAP Image / Bianca De Marchi

After 10 successive hikes, the fastest and largest tightening cycle of official interest rates in decades, the Reserve Bank finally paused on Tuesday. Lest anyone think that meant the worst was over, though, governor Philip Lowe quickly provided a reality check.

“The decision to hold rates steady this month does not imply that interest rate increases are over,” he told the National Press Club the following day.

“The board expects that some further tightening of monetary policy may well be needed,” he said, adding that its members were “conscious that monetary policy operates with a lag and that the full effect of the increases to date is yet to be felt.”

Lowe’s message this week was clear: things would get worse before they got better. Mortgage stress would likely intensify for another 18 months. “We anticipate that required mortgage payments will reach a new record high of almost 10 per cent of household disposable income by the end of next year,” he said.

He was talking averages, of course. Newer home owners with larger mortgages would be much worse affected. And the stress on those who rent – more than 30 per cent of the population – would be “at least as big an issue” as mortgage stress, he said. Rents would keep going up for “quite a while” – maybe five years.

Unemployment would rise in the latter half of this year, albeit from historically low levels, said Lowe. And the cost of electricity, which went up 11 per cent last year, would jump another 12 per cent in 2023.

Bottom line: this ratcheting up of official interest rates, from 0.1 per cent to 3.6 per cent, was only just beginning to bite. But it was biting hard, and would bite harder for months or years to come. Hence the decision, said Lowe, to “wait for a while to assess the pulse of the economy”.

That pulse kept racing well after the RBA started raising rates last May. In the June quarter last year, consumption grew by about 2.4 per cent, or four times the average of the previous decade, which was frighteningly fast. In the following three months it slowed considerably, but was still almost twice the average. In the final quarter of last year, consumption was barely half the average growth rate. Lowe presented partial data suggesting it was lower still in the first three months of this year.

“We expect that consumption growth will remain subdued for some time. But there are uncertainties, with factors pulling in different directions.”

On the one hand, unemployment remained – for now at least – at its lowest in 50 years, and people had accumulated additional savings during the pandemic equivalent to about 20 per cent of annual aggregate household income. “Partly reflecting these additional savings, the median owner-occupier with a variable-rate mortgage is more than a year ahead on their mortgage payments,” Lowe said.

On the other hand, cost of living pressures were squeezing household budgets, house prices had fallen, “and the 35 per cent of households with a mortgage are experiencing, or will experience, a significant increase in their required payments”.

What seems clear is that the pain caused by the rate rises over the past year, along with the inflation they were intended to control, will increase. The RBA board is just waiting to see how badly Australians are hurt, before they decide how much more pain the bank will have to inflict.

The trouble is, this assessment is complicated – Australia is suffering from a range of pre-existing conditions, and it’s hard to tell how much more stress can be absorbed without triggering them in ways that could be far more damaging.

The first pre-existing condition is the growth in wealth inequality over the past couple of decades. As Lowe consistently notes when talking about the current economic crisis, the pain of inflation is not borne equally by all Australians. But the pain of higher interest rates is also felt unequally. And that’s mostly due to economic inequality, which is, in turn, largely driven by ballooning house values. Indeed, had things been less unequal, the RBA might not have needed to raise rates so much, so fast.

“There’s a great big gulf between those affected by rate rises and those that aren’t,” says Brendan Coates, economic policy program director at Grattan Institute.

He sees a significant generational component to it. “You have a growing number of older Australians who either don’t have mortgages or have very small mortgages, and they are relatively unaffected [by rate rises].”

In fact, says independent economist Nicki Hutley, some of these people are beneficiaries of higher rates. “That is, those who own their homes outright and probably have nice fat super funds and who are enjoying having higher rates because it means they’re actually getting something back on their term deposit.”

The homeowners most affected, says Coates, are “overwhelmingly those in their 30s and 40s”. They are the ones who bought in the past five years or so, when prices were high and interest rates were low. They are middle-income earners who are saddled with high repayments.

“The wealthiest 20 per cent of households have a debt-to-income ratio of 1.0. Those at the bottom have a debt-to-income ratio of 0.3. But the middle quintile’s ratio is 2.27,” Coates says. A debt-to-income ratio of 1.0 is usually considered safe; more is risky.

Roughly a third of Australians have a mortgage. But, says Tim Reardon, chief economist of the Housing Industry Association, about two-thirds of those people are well on their way to paying it off or at least well ahead with their payments.

“So it’s a narrow segment of the Australian home owners that are significantly affected. They bear disproportionate burden of trying to abate inflation,” says Reardon.

Despite all the attention paid to mortgage holders, however, renters are in far worse trouble, and they are far more numerous.

According to data released this week by CoreLogic, rents went up by an average 10 per cent nationally during the past year. That’s well above the general rate of inflation, which was 6.8 per cent in the year to February.

Here the problem is both intergenerational and intra-generational, says Coates. “We see incredibly low rates of financial stress among older Australians, and that includes many pensioners. Pensioners who own their own homes have lower rates of financial stress than younger Australians that work,” he says.

“But renting pensioners, half of them are in poverty today. And those numbers have likely increased now that rents are rising as quickly as they are.

“The groups that are doing it hardest are those that are exposed to the vagaries of the rental market. The people we should be most worried about are those who were already in financial stress. And that is overwhelmingly low-income Australians who rent, particularly those on JobSeeker or Parenting Payment Single or Youth Allowance. But also many low-wage workers who aren’t eligible for income support.”

Another of Australia’s troubling pre-existing conditions is the lack of housing supply. Vacancy rates are below 1 per cent across all capital cities. And the situation is expected to worsen over coming years.

“You can’t blame the Reserve Bank for our housing affordability crisis,” says Hutley. “The root of the problem is government policies that constantly supported demand growth rather than supply growth.”

She’s talking about government measures such as first home buyer grants, which have simply pushed up the price of houses.

“There are other factors too,” she says. “A lot of it comes down to state and local government planning regulations, which would make a huge difference. We have to shut the nimbys up.”

And, of course, there is the fact that most rental properties are owned by mum and dad investors, who have mortgages on those rental properties, and who are pushing up rents to cover their increased borrowing costs.

The HomeBuilder scheme implemented by the Morrison government as a stimulus measure during the pandemic was a “classic example” of how not to go about funding housing, says Brendan Coates. “The government decided to top up the funds of wealthier households to spend on renovations, rather than using that money to help construct social housing to house our most vulnerable.

“Both would have boosted housing construction, but one would have done much more to solve big challenges in the community. It was a missed opportunity to direct spending, to achieve a broader set of social goals. It was a big missed opportunity.”

The failure of successive governments at all levels to increase the amount of housing stock has incurred great social cost, says Hutley.

“There are lives at stake – literally lives at stake here. The social costs of housing insecurity are absolutely astronomical. Homelessness, things like the impact of overcrowding on educational outcomes, on domestic and family violence. These are huge.”

And the housing shortage, decades in the making, is about to get much worse.

A report by the National Housing Finance and Investment Corporation this week predicted a shortfall of 106,000 dwellings by 2027, and was predicated on net migration of 250,000 a year. But net migration, as Lowe said in his press club speech – and as the HIA’s Reardon also notes – might well be double that number.

Gerard Minack, director of an independent economic and financial marketing consultancy, sees this resurgence of migration as a particular concern amid an already inadequate housing supply.

“Our principle economic problem before the pandemic was that we had a tight housing market, rising house prices and sluggish wage growth. The common denominator in all that was we were massively importing more workers that simultaneously was suppressing wage growth and tightening up housing.”

It’s a contentious argument that migration suppressed wages, but what cannot be denied is that it allowed government to pretend the economy was growing faster than it actually was.

“Politicians could point to half-decent GDP growth. Yet, what really matters for the average person is per capita growth. And in per capita terms, the decade up to the pandemic was, frankly, appalling. I think it was the worst decade of per capita income growth since the 1930s,” Minack says.

Call this stagnation in income growth the third pre-existing condition that has been brought into sharp focus by the current crisis.

A fourth, mentioned by Lowe in his speech, is power prices.

Prices have increased sharply, not because of increased demand: total consumption, he noted, has been little changed during the past decade. Nor was it just a function of the Ukraine war reducing global supply. “Domestic supply-side factors” were also to blame, he said.

He did not enumerate them all, but they are well-enough known that he did not have to. Price gouging by Australia’s gas producers was a big one. We can trace responsibility for that one back almost 15 years to previous Labor governments, federally and in Queensland, which approved the massive gas export facilities that then hoovered up excessive amounts to ship overseas, at the expense of domestic supply.

Lowe did mention the continuing challenge posed by “a mismatch in the timing between the ageing of existing generation capacity and the installation of new renewable supply”.

And for that we can blame the previous federal Coalition government. Scott Morrison famously declared his government’s intention to “sweat” old, breakdown-prone coal-fired power stations for as long as possible, instead of incentivising investment in renewables.

As Minack says, the policy incompetence on energy has been bipartisan.

In his Wednesday speech, Lowe lamented Australia’s poor productivity growth over recent years. While people were working more hours, labour productivity in the December quarter of last year was the same as it was three years earlier. More recently it has actually been going backwards. Without an increase in productivity, he said, consumption – and wages – would have to grow more slowly “if we are to avoid persistently higher inflation”.

Minack blames corporate Australia for this. Instead of reinvesting, they have simply been taking profits. The track record of corporate investment during the past decade, he says, has been “appalling”.

“Historically, non-mining investment used to fall to about 8 per cent in recessions. We’ve averaged 8 per cent of GDP for the last decade. In other words, business investment, outside mining, has been at levels that you’d only ever seen in recessions.”

The point is: there are many contributing factors to the current crisis, and they will need to be addressed through measures other than simply increasing interest rates. In the meantime, it is those who have the least ability to pay who are paying the most.

“Under every forecast,” says Hutley, “unemployment is rising this year. Even under conservative forecasts, you’re going from 3.5 per cent to 4.25 per cent over the next 18 months or so, you know, that’s a couple of hundred thousand people, potentially, who are not going to have jobs and not have the means to pay for somewhere to live.”

And the fact that the RBA has paused the rate increases for one month – or maybe more – is really no cause for complacency.

One last observation underscores the difficulty facing the RBA, and other central banks, in getting the have-lots to rein in their conspicuous consumption so the have-nots might suffer less. This past week, a new person was declared the world’s richest. That was Bernard Arnault, head of the French luxury goods empire LVMH. His wealth passed $US200 billion. He’s not seeing any shortage of demand from Australia’s wealthiest people to help add to his good fortune. Last month IBISWorld forecast that luxury retailing in Australia would grow 12 per cent this year, to $5.3 billion.

This is not just a short-term cost of living problem, it is simply part of an entrenched, accelerating problem of inequality.

This article was first published in the print edition of The Saturday Paper on April 8, 2023 as "Pause for effect".

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