The RBA's rationale for why it's not rushing to lift rates


The Reserve Bank of Australia (RBA) thinks the next move in official interest rates is likely to be higher should progress in lowering unemployment and boosting inflationary pressures continue in the period ahead.

However, despite calls from some academics, including a former Board member, that interest rates should increase now, it still sees “no strong case for a near-term adjustment in monetary policy”.

While these views are hardly new, heard on-and-off over the course of this year, the RBA provided plenty of reasons in the minutes of its July monetary policy meeting as to why it has little desire to deliver a preemptive increase in the cash rate, pointing to rising risks from abroad, as well as ongoing constraints for Australia’s highly-indebted household sector, as a reason to sit tight for the foreseeable future.

“Some of the downside risks to the global growth outlook had increased over the prior month,” the RBA said.

“Members noted that trade tensions extended beyond the United States and China, and could escalate through non-tariff measures such as administrative delays.

“An escalation of trade tensions could harm global growth by undermining confidence and delaying investment decisions and could dampen international trade.”

So the tit-for-tat trade war between the United States and China, seeing both sides increasing import tariffs on the other with the promise for more, is on the RBA’s radar — an understandable reaction given China is Australia’s largest trading partner and therefore highly influential on Australia’s economic fortunes.

Domestically, the board also discussed at length the high level of household debt in Australia at its July meeting, a timely conversation given Australia’s household debt to income ratio had recently increased to a record 190%.

It offered not only the factors behind the increase in household indebtedness, but also why it poses a risk, reinforcing the point that now is not the time to test the waters with an unexpected lift in official borrowing costs, especially at a time when domestic wholesale funding costs are elevated and uncertainty over whether these trends will persist.

“Household debt has increased by more than household income over the preceding three decades in many countries, but particularly so in Australia,” the RBA said.

“Two key drivers of this trend across countries have been the decline in nominal interest rates, predominantly reflecting lower inflation, and financial deregulation, both of which have increased households’ access to finance.”

It added that the higher cost of housing also reflected that a larger share of the Australia’s population live in urban centres, along with a preference for large, unattached dwellings among prospective buyers.

While the board noted that, based on survey data, that much of Australian household debt is owed by higher-income and middle-aged people “who tend to have more stable employment and often larger savings buffers”, it acknowledged that “a material share of household debt is held by lower-income households, which generally have higher debt relative to their income”.

That is, while most of Australia’s household debt is held by those the RBA deems can afford to service it, there’s still a significant proportion of the population who are vulnerable to higher borrowing costs.

“Members noted that high levels of household debt could affect economic outcomes,” it said.

“Households with high debt levels are more vulnerable to economic shocks and therefore more likely to reduce consumption in the face of uncertainty about their future income.

“Members also noted that changes in interest rates have a larger effect on disposable income for households with high debt levels.”

Put bluntly, Australia’s economy is only as strong as its weakest link, and by lumping higher debt servicing costs onto the most vulnerable households, it could lead to adverse economic circumstances.

At a time when progress in reducing unemployment and boosting wage and inflationary pressures is slow, if not glacial, why risk scuppering what’s already been achieved in the name of building an interest rate buffer that will be required at some unknown point in the future?

By increasing rates too early it could actually create an unnecessary downturn, forcing the RBA to cut rates even lower than where they currently sit.

Households may be able to absorb higher borrowing costs, but maybe they won’t. You’d want to be fairly certain they’d be able to cope before beginning the task of normalising policy settings.

Thankfully, the RBA doesn’t appear to be contemplating an early move, noting that “household balance sheets continued to warrant close and careful monitoring”.

“Since progress towards a lower unemployment rate and an inflation rate closer to the midpoint of the target range was likely to be gradual… the Board assessed that it would be appropriate to hold the cash rate steady and for the Bank to be a source of stability and confidence while this progress unfolds,” it said.

Until wage and inflationary pressures build to a sufficient level to provide confidence the economy can withstand higher borrowing costs, it’s likely to remain that way for some time to come.

The minutes of the July policy meeting can be access here.

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