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Inflation rates are at an all-time high in every part of the world. And they are still rising at a staggering rate. The lingering effects of the pandemic and subsequent Russian invasion of Ukraine impacted the production of vital goods and raised production costs. The RBA has been increasing loan interest rates to cope with this inflation.
Inflation has been high in Australia at its current 7.8% rate. Meanwhile, the reserve bank targets to keep the rate within 2-3%. To reach this target rate, the bank has raised the interest rate on loans nine times since May 2022. They hope that the increased rates will force people to spend less. Consequently, the demand and price of goods will fall.
The frequent increase of interest rates by the reserve banks might devastate you as a borrower. But you might feel more optimistic about the situation once you understand what’s it trying to achieve.
An Overview Of Inflation And Raising Interest Rates In Australia
Australian borrowers see the highest interest rates of the decade. On their ninth meeting in February since May-2022, the RBA raised the interest rates by another 25 basis points. This brought the overall interest rate to 3.35%. And this is not where it ends; as RBA governor Philip Rowe hinted, further increases are to come.
Further Increases In Interest Rates
Per the government’s statement, Australia is experiencing a historically high inflation rate of 7.8%. And the RBA will keep increasing the interest rates until it recedes to 2-3%. Although the energy prices are comparatively low and various supply chain problems have been resolved, reaching the inflation target will take some time.
In fact, the RBA has explicitly stated the possibility of interest rates rising by another 0.5% basis point in the coming months. This 50 bp rise will increase the interest rates to 3.85%. When that happens, the average Australian borrower might have to pay over $1000 per month for their typical five hundred thousand dollar mortgage loan.
In this scenario, it is natural to wonder when things will return to normal. Well, it will take some time. According to the governor’s statement, the RBA hopes the inflation rate will decline to 4.75% within this year. However, the inflation target of 2-3% won’t be possible until we are halfway through 2025.
The possibility of another increase in interest rates is high because the RBA is bent on avoiding a wage-price spiral. They would strictly analyse the wage-price index upon its release in the last week of February 2023. Based on their analysis, the borrowers might see another basis point increase.
The Effects Of Raised Interest Rates
These increased rates will surely devastate the average Australian. For instance, overwhelming mortgage payments will dramatically reduce household incomes. On the other hand, this will achieve the RBA’s target of making people spend less. Considering the 800 000 Australians moving to variable mortgage rates from a fixed-rate plan, the blow will be severe.
The rising interest rates shall also affect the GDP of Australia. On November 2022, the RBA made predictions of a 2% GDP in 2023. But now they have lowered their expectation and is predicting a 1.5% GDP this year.
There will also be an increase in unemployment. However, the RBA doesn’t expect the jobless rate to be too overwhelming. For instance, the last time Australia saw a 3.35% interest rate was in 2012. During that time, the unemployment rate was more than 5%.
However, this time the rate is lower. In December 2022, unemployment was around 3.5%. The RBA predicts the rate will only rise to 3.75% as this year reaches its end. And by mid-2025, it shall crawl up to 4.5%, which is still lower than last time.
Understanding Reserve Bank Of Australia’s Inflation Target
The whole reason RBA has been driving up interest rates is to reach the inflation target. That is, they try to keep the annual consumer price inflation within an average of 2-3%. Let’s see how that works.
CPI and Inflation Target
The RBA deems the changes in Consumer Price Index or CPI as a suitable measure of inflation. Because the CPI report reflects the price fluctuations of the products typical Australian buys. Also, the Australian Bureau generates the CPI independently. So, there can be no complaints about the report being biased.
The inflation target helps the banks in setting various policies. The RBA agreed on the 2-3% inflation target in the last decade of 1900. At the same time, many central banks of other countries took a similar approach. The banks try to achieve a stable price, healthy employment rates, and overall financial well-being of the public with their inflation targets.
The Reason For Increased Interest Rates
During times of high inflation, money loses its value. This reduces the purchasing power of consumers whose income doesn’t increase with the declining value of money. As a result, people can buy lesser and lesser products, the consequence of which is further inflation. Thus, diminishing purchasing power creates a vicious cycle.
When people can’t afford their daily necessities with their current incomes, they demand higher salaries from their employers. The employer then has two options to make up for these increased wages. Firstly, he will increase the price of his products. And secondly, he will fire some of his employees as he can’t afford them.
As businesses frequently raise the prices of their products, consumers don’t feel confident about the overall state of the economy. As a result, they invest less in the economy due to the uncertainty of the return.
Also, businesses don’t feel good about lending out money to borrowers. Because the agreed-upon interest rates don’t hold the same value with rising inflation. This means the loan givers will lose money on their investments. And if people can’t get loans, there wouldn’t be investments. All these accumulate to hinder the economic growth of the country.
Under such circumstances, the central banks have only one option to retain the investor’s faith in the economy. And that is to raise the interest rates. This ensures that lenders can receive their expected returns on investments and keep the wheel of the economy spinning.
Conclusion
Taking out a loan might seem scary during these challenging times of rising interest rates and inflation. However, your financial and life goals will suffer if you don’t do it. So, how can you still afford your goals while the rates keep increasing?
Well, EFT capital can provide a solution for you. We offer a variety of loans and services with fixed interest rates to help you in these hard times. You can apply for a loan online today.