The RBA and a 4% cash rate

RBA in the spotlight as interest rates rise.

Buckle in for an aggressive rate-tightening cycle.

The RBA has lifted the cash rate to 3.35% and we’re in store for at least 2-5 more increases this year.

Yet the inflation sting is fading.

Interest rate hikes are denting consumer spending, supply chains are recovering lost capacity, and the dust has settled on the energy market after Russia’s invasion of Ukraine.

Jerome Powell, the head of the US Federal Reserve, has even started talking about disinflation. He is confident that global goods and commodities shortages have been “fixed.”

The RBA also thinks inflation is headed down and yet it is ready to ramp up the financial pain. In its media release papers, the board expected inflation to slip from the current 7.8% to 4.75% by the end of this year, and to around 3% by mid-2025.

So why are rates expected to hit near 4% this year if the outlook is positive? Chris Curtis a buyers agent in Sydney has said that the market has cooled but there are bullish signs of a recovery in the 2023/2024 period.

Enduringly strong demand risks leaving us with high inflation in the long term.

The RBA is lifting interest rates to slow spending growth and bring demand in line with its calculated equilibrium. If people keep spending when inflation is high, businesses have no incentive to lower their prices. Without the punishment of reduced demand, business profit gouging makes high inflation entrenched in the long term.

And the pandemic has turned us into professional spenders not eager to cut back.

When you were stuck at home in your trackies and a hoodie, there was nothing more exciting than an order from The Iconic or a new Dyson vacuum.

The strength in goods consumption was especially pronounced for home entertainment, appliances, furniture, and home renovation. In June 2020, retail sales for these categories was 20-30% higher than the previous year. Seasonally adjusted retail trade volumes also rose by 8.2% in 2021 and by 7.5% in the 12 months to December 2022. Even as prices were increasing, businesses were paradoxically rewarded by growing consumer spending.

Furthermore, the sheer scale of these increases will require an equally mighty fall in retail spending to get things back on track. What the RBA wants to see is people kicking the can of planned future purchases down the road with the force of a Ronaldo kick.

The key message is delay, delay, delay!

The RBA believes that domestic demand for goods is too ‘strong’ despite falling 3.9% in the December quarter. If they could give out a fortune cookie, it says to hold off on your purchases and good things will come. Except they wouldn’t give you a cookie. Just the paper.

If people are no longer consuming then businesses will have to lower their prices with discounts and deals to lure them back in. Low demand is the perfect tonic for high prices.

This is why the RBA will keep raising interest rates. They want to inflict financial pain on borrowers now to reduce demand and shoulder the burden onto businesses who can afford it later.

But the RBA’s policy decisions are not guaranteed to shift its targets quickly.

They want to make life harder for households so they choose to cut back on goods. The crucial word there is a choice. It is a game of psychology. This is the challenge the RBA is trying to overcome. How does it moderate spending without sending families bankrupt?

The latest 25 basis point jump brings the total repayment increase to over $26,000 a year on a $1,000,000 mortgage. But our frayed nerves about mortgage repayments won’t turn the tide until demand is thoroughly reduced.

There are early signs of change. Since the RBA’s first rate rise retail spending on electronics has fallen 9%, recreational goods has fallen 6% and personal accessories by 4%. Yet demand needs to weaken even more dramatically for there to be any easing of the cash rate.

We are in this for the long haul.

To make matters worse, near zero interest rates should never have been the norm.

The current rate tightening we are seeing is a return to conventional central bank activity. So rates nearing 4% are not out of the question.

If rates do go that high the RBA can be more nuanced with its monetary policy.

Why is that? Because rates need to be elastic for them to have a meaningful effect.

Interest rates live a double life. On one hand, they are supposed to smooth out inflation and on the other, they are supposed to maintain steady investment from the private sector. Rates are supposed to fall when the economy is underperforming and rise when the economy is moving too quickly. It can be a rocket one day and a parachute the next.

This approach helps balance the central bank’s competing goals of encouraging economic growth and maintaining price stability. So over the past decade, interest rates should have adjusted to account for changes in supply and demand, right?


In the decade following the GFC, the RBA consistently lowered interest rates and brought them to a record low of 0.1%. This fuelled unprecedented inflation of assets. The heavy metal gates to lending Valhalla were replaced with French sliding doors and we grew our debts. According to the ABS, average household debt in Australia was over $260,000 in 2021-22, which is among the highest in the world.

Furthermore, weak private sector investment has forced a rapid expansion of government balance sheets. Booming spending on health, business support, and social services has resulted in outstanding liabilities increasing exponentially. This drove down interest rates and left economies more highly strung than ever before.

Gross fixed capital formation for private non-financial corporations was relatively stagnant in the decade following the GFC. Despite the low interest rates they were hesitant to make investments which would boost their productivity, increase employment, and lift government revenue from their tax receipts.

So the RBA was being swayed by the business cycle but its decisions were impacting consumers and the government. This damaged the effectiveness of its rate movements. It now needs to hike rates to return to conventional monetary policy to give it the flexibility to change and to keep prices stable. Talk of rates at nearly 4% is not a pipe dream but an understanding that rates naturally move up and down.

What we’re seeing now is a return to the hawkish rate cycles which stabilised government budgets and inflation in the past.

The current rate tightening is actually a necessary return to flexible rate movements which gives us the space to navigate booms and busts more effectively. Near-zero interest rates should never have been the norm. As rates continue to lift we move into a new normal which gives us more freedom to direct the economy.

If the RBA were playing chess, they would be swapping out a Pawn for a Queen.

The RBA will hike aggressively over the next six months.

The Australian economy is drinking an unfortunate cocktail of high demand, inflation above target, and high government debt. Though conditions are expected to improve throughout the year, the RBA will not budge on its contractionary path until demand is significantly dented.

We need to see businesses feeling the pain and lowering their prices before we can expect any mortgage relief. So if you want to help accelerate the shift, delay your spending and look for discounts where you can.

You can also take comfort in the knowledge that elevated rates are normal and not something we should resist.

About the author

Ulrika Lobo

Ulrika Lobo is the lending specialist at Sparrow Loans and has over ten years of experience in the commercial business loan space. Ulrika co-founded Sparrow Loans to provide Australian SMEs with a faster and easier way to access finance. Ulrika is responsible for managing the lending process from underwriting to execution and settlement and post-settlement support.