Earlier this week, the Reserve Bank of Australia surprised the market with a greater than expected increase in the cash rate.
In response to rising inflation and low unemployment, the central bank took rates 50 basis points higher to 85 basis points.
Governor Philip Lowe explained why the Reserve Bank made the move. He said:
Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected. [..] Inflation is expected to increase further, but then decline back towards the 2–3 per cent range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago [..]. Today's increase in interest rates will assist with the return of inflation to target over time.
Unfortunately for borrowers, the central bank acknowledges that this rate hike, as large as it was, won't be enough to tame the inflation beast. Mr Lowe has warned that more hikes are coming and soon. He explained:
The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board's assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.
Where are rates going?
If you thought that 0.85% was a shock to the system then you might want to hold onto your hat.
The ASX 30 Day Interbank Cash Rate Futures provide investors with an idea of what the market is expecting from the Reserve Bank over the next 18 months. And it certainly isn't pretty for borrowers.
Here's what lies ahead for the cash rate between now and this time next year according to futures:
| Jul | Aug | Sep | Oct | Nov | Dec | Jan | Feb | Mar | Apr | May | Jun |
| 1.55% | 1.63% | 1.96% | 2.35% | 2.8% | 3.02% | 3.09% | 3.31% | 3.46% | 3.59% | 3.68% | 3.7% |
This means that the market is now pricing in the cash rate reaching 3% by Christmas, after which it is expecting rates to continue to rise to 3.7% by this time next year.
Given this expected rapid rise and the impact it could have on borrowers and the economy, it's no surprise to see Commonwealth Bank of Australia (ASX: CBA) shares, the rest of the big four, and the ASX 200 index behaving so volatile this week.
Time will tell how accurate the market is with its predictions.
