The Lower Cash Rate in Australia

September 15, 2023

Ever since thoughts first turned to rate hikes at the beginning of 2022, financial markets have believed that the peak in Australia’s cash rate would be below that of the US. That has also been the case for financial markets views about the peak in the cash rate relative to New Zealand. Expectations that Australia’s peak cash rate would be below that of the UK and Canada though is something that has only happened this year.

Historically, Australia having a lower cash rate than the US is not typical but is also not unusual. The Australian cash rate was higher around the turn of the century at a time when the US economy was feeling the fallout from the equity market ‘Tech Crash’. It was again lower prior to the pandemic when the Australian economy was still feeling the pinch of the end of the mining boom and the US economy was powering ahead, boosted by fiscal policy.

This time, though, there is no obvious difference in economic cycles to explain why the Australian cash rate will peak under that of the US. According to RBA figures, the growth of GDP per capita (per person) has been about the same in Australia and the US (it has been slightly higher in the US). The unemployment rate in both countries is around 3.5%. Core inflation in both countries peaked at around 6%.

The RBA has put the likelihood of a lower cash rate in Australia down to three possibilities:

1. The first is that the RBA is happy to have a slower return to their inflation target than other central banks to (hopefully) keep the unemployment rate relatively low.
2. A second factor is that wages growth in Australia has been below peer countries. This has been the case. And it may remain the case. But the Wages Price Index data showed that for those in the private sector that received a pay rise, wages growth in the June quarter (at 4.5%) hit a record high (the reason for the modest total quarterly increase was the seasonally low number of workers that received a pay rise). Wages growth matters because it is the key cost for firms, particularly for a large part of the services industry. But as the RBA themselves emphasise what really matters for the inflation outlook is not so much wages growth but the growth of unit labour costs. Australia’s low productivity growth has meant that unit labour costs are rising faster than in peer countries.
3. The other possibility flagged is that the higher proportion of variable rate mortgages in Australia means the transmission of interest rates impacts the Australian economy quicker than other economies (most notably the US where the most common form of mortgage is a 30-year fixed rate). This is true although Australia has had a higher proportion of variable-rate mortgages for a long time. And the proportion of fixed rate mortgages written in Australia between 2020-22 was higher than usual.

In coming quarters, real household disposable income growth will be hit by conflicting forces. Interest payments will take a bigger chunk out of incomes while inflation will become less of a negative. Wages growth is likely to head a little higher. Most forecasters expect a rise in the unemployment rate (particularly in 2024), although Australia’s jobs market still looks strong by peer country standards. Income tax cuts are due to be delivered in the second half of next year.

In net terms, it is likely that real disposable income growth will improve in coming quarters. The question then will be how much of that improvement will be spent. Recent surveys suggest that rising interest rates has led to a growing proportion of households indicating they will use their additional funds to repay debt (or rebuild saving).

The Australian cash rate looks likely to peak below that of peer countries. The good news is that pressure on household budgets should improve as inflation declines over the next year. Households are likely to save a fair slice of that extra income, particularly given the probable weakening of the jobs market. The answer to that question will play an important part in determining how the economic and inflation outlook evolves over the next year.