This is the first rate rise the RBA has put through since it raised from 4.5% to 4.75% on Melbourne Cup day in November 2010.
The rate hike was largely anticipated by the market. However, the surprise was that it was a full 25 basis point (0.25%) increase to 0.35%. Many were expecting a 15 basis point increase to 0.25% before returning to the usual 25 basis point increments.
The market is anticipating further rate hikes throughout the year with the market pricing in a 2.765% cash rate target by December 2022. This is shown on the chart below produced by the ASX.
Impacts of Rate Rises
Many households would no longer be able to afford repayments on their home loan (or rental property) mortgages. Putting this aside, it would likely suggest lending standard have been too loose in the last 2 years. The media are already reporting that 300,000 people may not be able to afford their mortgage with the current rate rise.
This has many knock on effects that will impact the economy. Higher rates could cause defaults and loan losses, which will impact bank (and shareholders’) profits. It may turn many home-owners into home-sellers and in turn putting downward pressure on the housing market.
Higher rates will reduce the appetite for household and business borrowing, which will reduce economic activity – as it is designed to do. Reduced economic activity could lead to a decrease in GDP, which is otherwise known as a recession. This would be Australia’s second recession in 2 years.
Why are the RBA rising rates now?
Firstly, the number of Australian dollars in circulation has increased 23% since the beginning of 2020. Economics 101 says that when the supply of something increases, it’s value goes down. Applying this to dollars, when the money in circulation increases, more money is available to spend on the same amount of goods and services, which results in prices increasing.
Further, fiscal stimulus from the government combined with major spending items such as travel not being available redirected large sums to other areas such as cars, real estate, and home improvements. Thus pushing up the cost of cars, housing, and the cost of building products.
Increasing supply-side costs have featured heavily in recent conference calls and media releases from companies on the ASX, with some companies saying they have been (or expect to) be able to pass on the price rises. It is these companies that we gravitate to naturally, as pricing power typically comes as part of an enduring competitive advantage, which is core to our investment philosophy.
This will continue to negatively impact the prices of assets, but we believe that investing in quality companies that have pricing power and likely to continue growing earnings over the long term is the best way to hedge against inflation and further cash rate rises.
Written by Luke Durbin
Oracle Investment Management