UK raises the cash rate – will Australia follow suit?

On 15 December, the Bank of England’s Monetary Policy Committee (MPC) agreed by a majority of 8-1 to increase the bank rate by 15 basis points, to 0.25 per cent.

The bank has estimated that the increase may see mortgage repayments increase by around £10 a month (based on rates rising by 15 basis points on a £130,000 mortgage being repaid over 25 years on a variable interest rate of 2.5 per cent). 

The move made the UK one of the first economic powerhouses to raise interest rates since the pandemic began - propelled by rising inflation.

Indeed, the UK’s 12-month Consumer Price Index (CPI) inflation rose from 3.1 per cent in September to 5.1 per cent in November - with the rate of inflation accelerating as the country battles escalating COVID-19 cases due to the highly contagious Omicron variant (and associated impacts) as well as high energy costs and low wage growth.

While the central bank’s move will help reduce the rate of inflation, its forecasts still expect CPI to hit 6 per cent by April (with the continuing increase driven by “the lagged impact on utility bills of developments in wholesale gas prices”).

Therefore, in order to keep inflation within the 2 per cent target by the end of 2023, the Bank of England said it had needed to raise rates and “may need to raise interest rates again over the next few years”.

While Australia’s base rate has also held firm at 0.15 per cent over the past year, there has been mounting expectation that the Reserve Bank of Australia (RBA) may also look to raise rates soon (although its first meeting isn’t scheduled until February 2022).

However, here in Australia, annual CPI inflation is around 3.0 per cent - much lower than that of the UK (and the US, another major economic powerhouse) - and actual inflation is far off being comfortably within the 2–3 per cent target range that the RBA has said the country will need to see before it thinks about increasing rates.

Even in its central scenario forecasts, the condition for an increase in the cash rate will not be met next year. 

In a speech given to the CPA Australia Riverina Forum last week, RBA governor Philip Lowe explained: “In underlying terms, inflation is 2.1 per cent and has only just returned to the 2–3 per cent target range for the first time in six years. In headline terms, it is higher than this at around 3 per cent, largely due to higher prices for petrol and constructing a new home. Nevertheless, headline inflation in Australia is much lower than it is in the North Atlantic.

“Two factors help explain much of this difference. The first is the different dynamics in electricity and gas prices. Here in Australia, electricity prices have declined, while, in contrast, they have increased sharply in a number of countries.

“The second factor is that wages growth remains relatively low in Australia. While aggregate wages growth has picked up recently, it has only returned to the low rates prevailing before the pandemic). There are certainly hot spots in which wages are [increasing] briskly, but most workers are still receiving wage increases starting with a two, and sometimes lower than this." 

“The RBA is expecting wages growth to pick up further but, at the aggregate level, to so do only gradually,” Mr Lowe continued, highlighting wage-setting processes, which include enterprise agreements that tend to only get renegotiated once every two to three years, the annual review of award wages by the Fair Work Commission and public sector wages policies.

“The expected pick-up in wages growth is forecast to be associated with a steady but gradual increase in inflation in underlying terms," he said.

“In the RBA's central scenario, published in early November, underlying inflation is expected to increase to 2.5 per cent over 2023.”

While Mr Lowe has acknowledged that the RBA will weigh up how other central banks have acted when deciding the cash rate, much will depend upon how the economy, labour market, spending and inflation fares between now and the RBA’s first meeting in February.

As such, the RBA is unlikely to raise rates in Australia any time soon.

[Related: RBA governor stays firm on rate freeze in 2022]