When will the RBA start decreasing rates?
A quick analysis comparing historical cash rates to CPI
The above chart (Fig1) compares the Australian Cash Rate Target (blue line), which is set by the RBA, to the quarterly reported CPI (red line). The yellow line is the Real Interest Rate (cash rate minus CPI).
Interestingly, Australia has been in a period of very low to negative real interest rates since 2014; with the last rate rise (pre-COVID) coming in 2010. Negative real interest rates is a form of monetary policy set by the country’s central bank. It is comparable to Quantitative Easing (QE), or money printing. In response to the GFC, the U.S. implemented three QE programs to simulate the economy and increase/maintain GDP. Australia did not print any money post GFC to pre-COVID period, however as seen in the above chart, the RBA practised negative real interest rates. With negative real interest rates, saving is disincentivised in the hope to increase spending and consumption, subsequently increasing GDP.
So when will the RBA start reducing rates?
Using the available data, the RBA has only once started decreasing interest rates with a negative real interest rate (Nov 2020 – along with Yield Curve Control), every other time the RBA has only decreased the cash rate target during periods of positive real interest rates. Therefore, history suggests the RBA won’t pivot until a positive real interest rate is reached and maintained.
Similarly, from the four rate hiking cycles since 1990, the RBA has never ended a hiking cycle with negative real interest rates. This is comaprable to the U.S., where the Fed hasn’t ended a hiking cycle with negative real interest rates since 1954 (source).
The chart below (Fig2) highlights the Aust Cash Rate Futures, suggesting the cash rate will peak at 3.8%, with rate cuts coming at the end of 2023.
So if the RBA can control inflation and cut CPI down to 3.55% whilst raising rates to 3.8%, the real cash will be positive at 0.25%. However, if CPI doesn’t want to decrease, similar to the 2000-2001 period (see Fig1), the RBA may need to keep rising rates well above 6%.
It will be interesting to see how both the RBA and inflation reacts, noting that the full effects of an interest rate rise (response lag) can take 18-24 months (source). Plus Australia will be receiving monthly CPI figures starting in October 2022.