Recent interest rate hikes are expected to slash household spending by between 0.4 and 0.8 per cent, the Reserve Bank estimates.
The four percentage points of monetary policy tightening since May last year is starting to slow growth in demand and bring down inflation, RBA assistant governor Christopher Kent confirmed in a Bloomberg address on Wednesday.
The senior central bank official walked through the various ways higher interest rates were working to weigh on demand in the economy and take the sting out of too-high inflation.
In Australia, the cash flow channel is the most “obvious” due to the prevalence of variable rate mortgages and fairly short fixed-rate terms.
This channel has been operating with a larger than usual delay, Dr Kent said, due to the abnormally high share of fixed rate loans.
He said household mortgage payments – interest plus scheduled principal repayments – had risen from around seven per cent of household disposable income to almost 10 per cent – above the estimates of the peak reached in 2008 when the cash rate was 7.25 per cent.
“And for those households with a large mortgage, required payments are a much higher share of their income,” Dr Kent said.
The share of household income to repayments would keep going up as more borrowers rolled off their fixed-rate loans, but he noted that a large share of these low-cost loans had already expired.
“Many borrowers have had to cut back on spending to meet higher mortgage payments, while also feeling the pain of rapidly rising living costs,” he said.
“This has led to slower growth in demand for goods and services.”
Dr Kent said there were other ways interest rate movements influenced demand and therefore prices.
He said interest rates also bolstered incentives to save, even for households that had built up big buffers during the pandemic.
“Households with debt also have an incentive to save more; some may be able to pay down their debts ahead of schedule or at least run down their savings buffers more slowly than otherwise,” he said.
Higher interest rates also affect the cost of capital for businesses and determine whether they choose to invest.
RBA modelling implies that the four percentage point increase in the cash rate might contribute to a four per cent decrease in business investment than otherwise after two to three years.
“Tighter monetary policy is working to slow the growth of demand and bring it into better balance with supply,” he said.
“This is contributing to the decline in inflation.”
And while higher interest rates are working as intended, the RBA official kept the possibility of more increases alive.
“The board is paying close attention to economic developments here and overseas, and some further tightening of monetary policy may be required to ensure that inflation, which is still too high, returns to target in a reasonable time frame,” he said.
(Australian Associated Press)