Earlier this year, the Reserve Bank of Australia (RBA) lifted the cash rate for the first time in over 11 years.
The economy is growing strongly; unemployment is at its lowest in 48 years, inflation is at an all-time high and wage growth is accelerating. Forecasts show that the cash rate could hit 2.5% by the end of 2022, as the RBA takes further steps to curb inflation and monetary conditions in Australia.
Why is rising inflation linked to a rise in interest rates?
In a general sense, central banks, like the RBA, raise and lower interest rates to stimulate economic growth and control inflation. Like the present economy, when inflation is high, RBA might raise rates to try to control it. If it’s low, they may lower rates to encourage consumers to spend and borrow money.
- Interest rates are the primary tool used by central banks to manage the rates of inflation.
- Raising interest rates makes borrowing money more expensive, but it can also lead to more returns on savings and super (which earn interest on growth).
- When borrowing becomes expensive, this can also mean less demand for goods and services.
- The RBA cuts interest rates when the economy slows down to re-invigorate economic activity and growth.
- The goal of cutting rates is to reduce the cost of borrowing so that people and companies are more willing to invest and spend.
- Interest rate changes bleed to many facets of the economy, including mortgage rates and home sales, consumer credit and consumption, and stock market movements.
When interest rates increase, this causes goods and services to become more expensive because borrowing money becomes more expensive. On the other side, when demand decreases, prices decrease too, which reduces inflation.
Impact of higher interest rates
- Increases the cost of borrowing: With higher interest rates, interest payments on credit cards and loans are more expensive. Normally, this discourages individuals from borrowing and spending. People who already have loans will have less disposable income due to spending more on interest payments.
- Increased incentive to save rather than spend: Higher interest rates can often make it more enticing to save money in a deposit account because of the interest earnt.
- Higher interest rates affect people differently: The effect of higher interest rates does not affect each consumer equally. For example, reducing inflation may require interest rates to rise to a level that causes real hardship to those with large mortgages. However, those with savings may actually be better off.
- Commercial implications: In Perth particularly, we have seen large projects and funding required for major construction projects impacted. For example, the decision by St Barbara Mines to not proceed with expansions of their operations due to significantly higher capital costs associated with labor shortages, difficulty in the procurement of equipment and construction delays.
The bottom line
The Reserve Bank of Australia steps in to cut rates when the economy falters. It is reactionary to rising inflation or a recession, and uses this tool to lower the cost of borrowing so that companies and residential households can spend more and invest. The ultimate objective is to keep the economy moving with minimal disruptions.
Griffin Valuation Advisory believe that with all of these factors, rising interest rates, higher inflation rates and tight labour market conditions as well as Original Equipment Manufacturer (OEM) lead times, the upward pressure on project costs are having a significant effect on the costs of new construction projects, across Australia. This is, in particular, affecting the larger resource and commodity states of Western Australia and Queensland, which have large new mining & resource projects in the pipeline and some considerations to deferring these due to the very high construction costs and labour shortages in the current marketplace.