When will Australia’s exchange rate stabilize? And what is a “normal” interest rate?

There has been a lot of speculation surrounding recent monetary policy decisions by the Reserve Bank of Australia (RBA). As we navigate global pressures on our economy, it is reasonable to wonder where Australia is and when things will return to normal. But what is “normal”?

Notable events such as the global pandemic and Russia’s war in Ukraine have destabilized a range of industries, causing supply shortages and inflationary demands around the world.

Australia’s annual headline inflation rose sharply in the second quarter of the year, raising concerns return of stagflation: a declining economy suffering from high unemployment and runaway inflation – an economic concept that has not been experienced since the 1970s.

RBA Governor Philip Lowe has repeatedly this year advocated “normalize monetary conditions” removing some of the fiscal support put in place to help the Australian economy weather the pandemic.

The RBA increased the official exchange rate 175 basis points since May, from 0.10% to 1.85%. Prior to this year’s decisions, the last cash rate increase was in November 2010.

After further investigation of the historical data we can determine that the average cash rate between 1990 and 2022 was 3.86%, peaking at 17.50% (January 1990) and falling to an all-time high of 0.10% (November 2020). Is something in the 4% range the sweet spot to aim for? How does this 30+ year average compare to Lowe’s assessment?

What is normal?

During a media scrum over the monetary policy decision to raise the interest rate in May, the RBA governor said he expected a “normal cash rate” to be at about 2.5%. However, he clarified his comments and said he didn’t want to be stuck on any particular number.

“I think it is quite plausible that the neutral real interest rate is positive. If the economy can generate reasonable productivity growth, I’m sure the neutral real rate is positive. So my coverage here is really around the fact that I don’t really have a good idea of ​​what the underlying productivity growth in Australia is likely to be. The higher it is, the higher the neutral real rate will be,” he said.

“I think it’s at least zero in real terms, which would mean going back to 2½%. And whether we need to have higher interest rates than that remains to be determined, but it really depends on how you feel about the underlying productivity growth.

Lowe also revealed that the RBA is determined to return to “business as usual” as soon as possible when it comes to future decisions on cash rates.

“In the past, 25 basis points was the standard amount we moved. We’ve deviated from that a number of times in the past because circumstances demanded it, but 25 basis points is the standard move,” he said.

However, over the past three months, the RBA has raised the policy rate by 50 basis points each time to 1.85% in August. Some economists suggest it will exceed 3% by the end of the year.

Lowe proclaimed that the Australian economy had performed better than expected this year and that this had been the catalyst for the RBA’s pullback on its claims rates won’t rise until 2024.

Rising interest rates and soaring inflation

“The unemployment rate has gone down. The economy has been strong. Australians have shown resilience, they have adapted and interest rates are normalizing much faster than we thought,” he said.

“The main tool for adjusting monetary policy is the return to the cash rate and we are going back to this world of normality where interest rates are moving because of the results on inflation and on the labor market and that will be our tool of choice from now on.

Inflation is affecting every aspect of Australian finances right now, from lettuce cost at home loan rates. The RBA predicts that inflation could reach 7% by Christmas and that it will not start to decline until at least the beginning or the middle of next year. When do experts think it will peak?

The the big four banks plan further hikes in the coming months and next year. Some economists believe Australia could enter a mild recession by the end of 2023. Preparing for financial difficulties can put you in a better position to meet whatever challenges come your way.

Better understanding causing interest rates to rise can help you decide when to borrow money from banks, for example home loans, personal loans, car loans and credit card.

If the interest rate on your home loan is making your repayments unaffordable, consider comparing refinancing options.

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