The Reserve Bank has increased official interest
rates for the second time in four months, lifting the cash rate by a quarter of
a percentage point (25 basis points) to 6.00%. It is the seventh
increase in the current interest rate cycle that began just over four years
ago.

I’m not expecting a follow-up rate hike in
the next few months as it would lift the
chances of recession to 50%. The latest rate hike, together with the previous
move in May, and higher petrol prices have largely gobbled up the recent tax
cuts, leading to much slower economic growth. Interest rates have a bigger
impact on the economy now than when rates hit peak levels in both 1990 and 1994. As
a result, the sharemarket will likely struggle to find forward momentum in the
next few months.

Repayments on the average home loan of $222,200 are
likely to rise by $35.70 a month in response to the decision to lift the cash
rate. Following on from the May rate hike that lifted mortgage payments by
around $35 a month and the $31 increase in petrol spending, the average
household is around $100 a month worse off since the start of the year.

Around 2.8 million households will be directly
affected by the decision to increase interest rates, impacting 8.7 million
people. But that is just the start of the ripple effects felt through the
economy. Those 8.7 million people are likely to cut spending in coming months,
businesses will therefore receive less income, those businesses will, in turn,
spend less and hire fewer workers.

In dollar terms, some households will probably still
be marginally in front – the tax cuts just offsetting higher mortgage repayments
and rising petrol prices. But people generally don’t know the state of their
finances down to the last cent; rather it’s perceptions that matter. Australians
generally will perceive they are worse off and will be much more careful about
parting with their hard-earned dollars.

On the surface, a small 25 basis point rate hike
appears modest. But once the effects ripple through the economy, affecting
spending, profits and employment, the end result will be much more significant,
especially given the fact that Australians have higher debt levels than in the
past.

For the 35% of households paying off a
mortgage, life has just got a little tougher.

Peter Fray

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