Impact of Rising Inflation in Australia and How it is Driving up Interest Rates

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Introduction: What is Inflation and How Does it Affect Interest Rates in Australia?

Inflation is an important economic indicator that can significantly impact interest rates in Australia. 

It measures the rate of increase in prices for goods and services over time, and when it rises, it can also cause interest rates to increase. 

The Reserve Bank of Australia (RBA) sets the official interest rate for the country, which affects mortgages, business loans, and other forms of credit.

Inflation can affect interest rates because central banks, such as the RBA (Reserve Bank of Australia), control inflation. Interest rates and inflation tend to move in tandem. 

When inflation rises, banks raise interest rates to encourage individuals to spend less and save more.

The following statistics were determined after a thorough research was conducted:

  • In the December quarter, the CPI grew by 1.9%.
  • The weighted median price increased by 5.8%.
  • Rents increased by 4%.
  • Power bills rose by 8.6%.
  • Domestic vacation and trip accommodation increased by 13.3%.
  • International vacation and trip accommodation increased by 7.6%.

The clear message from these statistics is that prices are rising quickly across the range of the Australian economy.

The leading four banks forecast that the dust will settle with an official cash rate peak of between 3.35% and 3.85% – thus, getting there entails still more rate hikes in the first half of 2023.

What are the Risks for Australians if Inflation Increases and Interest Rates Rise?

The actual worth of money decreases. People can afford fewer products and services if prices rise faster than nominal wages.

Investment returns may be lower. Inflation impacts investment decisions since higher inflation rates diminish the real return on investment. Borrowers’ actual interest payments to lenders can also be affected by inflation. 
For example, inflation is higher than projected when the loan is agreed upon. In that case, the lender will receive less than expected because inflation affects the purchasing power of their interest earnings.

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What does that mean for RBA?

The RBA board is sure to raise the interest rates by 0.25 percentage points at its next meeting, which will be held on February 7.

To keep inflation between 2% and 3%, the bank must further lower aggregate spending in the economy, which can be done by raising interest rates.

A higher cash rate will help increase the dollar’s value by encouraging people to hold Australian dollars. This will help to make imports cheaper than they would otherwise be.
It will also result in higher loan repayments for mortgage holders. As the amount of money borrowers can afford diminishes, the economy loses more spending power, and property prices fall. Higher mortgage payments will also reduce consumer expenditure and lower inflation in 2023.

Economic Forecast for 2023: What Does it Mean for Australian Consumers?

The Australian Reserve Bank expects annual inflation to be close to 8% in the year ending December, decreasing to 4.7% by the end of 2023 and easing further to just over 3% by the end of the following year.

Real GDP growth is expected to be 4% in 2022, 1.9% in 2023, and 1.6% in 2024. Inflationary pressures erode household purchasing power, prompting the Reserve Bank of Austto to boost interest rates aggressively. The tightness in the labour market is projected to ease as growth slows. As the labour market cools and supply chain bottlenecks alleviate, inflationary pressures will reduce.