Finance Finance News Eight rate hikes in two years? Our economy should be so lucky!

Eight rate hikes in two years? Our economy should be so lucky!

john edwards
Dr John Edwards said rates would only rise if the economy substantially improves. Photo: ABC
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A widely-misreported warning of eight rate hikes in two years would in fact be good news for the economy, according to the man who made the prediction.

Dr John Edwards, former economic advisor to Paul Keating, former RBA board member and former chief economist at HSBC, struck fear into the hearts of mortgage holders this week by supposedly forecasting that the official cash rate would rise from 1.5 to 3.5 per cent by the end of 2019.

He actually wrote that the RBA would be forced to lift rates to 3.5 per cent only if the Australian economy substantially improved.

“This implies that within three years Australia’s economic world has returned to more-or-less normal, with wages growth of 3.5 per cent, inflation of 2.5 per cent, and output growth of 3 per cent,” Dr Edwards said.

He admitted such a rosy outcome might never eventuate.

“The pace of tightening will anyway be governed by the strength of the economy,” he wrote.

“If household spending weakness, if the long expected firming of non-mining business investment is further delayed, if the Australian dollar strengthens, if employment growth is persistently weak, then the trajectory of rate rises will be less steep and the pace less rapid.”

The piece prompted warnings that households would be forced to pay hundreds more a year in mortgage repayments, but Dr Edwards himself feared no such disastrous outcome: “The increases will cause less distress than will be widely observed.”

He said this was because housing interest payments were at 7 per cent of household disposable income, compared to 9.5 per cent in 2011 and 11 per cent just before the US-triggered global financial crisis.

These figures ignore the enormous impact of principal repayments. But the latest census data confirmed his point, showing that most parts of Australia were paying less overall on their mortgages than five years ago.

Dr Stephen Koukoulas, former economic adviser to Julia Gillard, said the economy would have to be “on fire” to necessitate eight rate rises, which would be “fantastic” news for workers.

He said GDP growth would have to be closer to 5 per cent, inflation 4 per cent and unemployment 3 per cent for the RBA to push the cash rate up by 200 basis points.

“If it comes to pass, it’ll be because the economy is in an inflation-inspired boom,” Dr Koukoulas told The New Daily.

Such a boom would help regular Australians because inflation is largely driven by household consumption, and “you need wages growth to underpin household consumption”.

A key factor is that the RBA sets the cash rate to target core inflation of 2 to 3 per cent over the medium term.

Because inflation has been below target for so many years, the central bank might allow it to sit at 3.2 or 3.3 per cent for a similar period of time, Dr Koukoulas said.

“There is a serious discussion among central banks that because of the hangover of the GFC, with low inflation still being recorded, let’s tolerate a year or two of above target inflation and let the unemployment rate get back down a little bit.”

Core inflation would only sit persistently above 3 per cent over the next two years if workers were “swimming in cash”, offsetting higher mortgage payments, which Dr Koukoulas said was an “improbable” but “fantastic” scenario.

Tom Kennedy, economist at JP Morgan, saw no such wage boom on the horizon.

In a research note on Thursday, he said next month’s minimum hourly wage increase of 3.3 per cent would be wholly offset by the much-publicised reduction in Sunday penalty rates.

Structural changes, such as underemployment and the increasing share of lower-paid services jobs, meant that the unemployment rate (currently 5.5 per cent) “most likely understates the slack” in the labour market, Mr Kennedy wrote.

Workers would have to get substantially more jobs and hours to enjoy wage rises, he said.

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