Shock interest rate rise shows Australia’s economic exceptionalism is fading

In a world of economic shocks, the questions left by Tuesday's surprisingly large increase in the official interest rate include what will bring the next thunderbolt.

After all, not one of 32 economists surveyed ahead of the Reserve Bank's monthly meeting predicted the board would emerge with a 25 basis point cash rate increase, finally liberating it from the record low 0.1% it had hovered at since November 2020.

Equally galling for forecasters had been last week's inflation figures, which nobody saw landing with a "5" on it. The RBA governor, Philip Lowe, described the CPI as "a shock" at his post-meeting media conference, and it was clearly the prompt for the rate hike.

People generally only like surprises that come with wrapping and a bow on them. After Tuesday's upsized rate rise - economists had mostly tipped a 15 basis point increase to 0.25% - economists reached for their slide rules, phone calculators and/or ouija boards to work out where the next jolt might come from.

Dashing hopes that the next nugget of novelty is easily prospected, David Plank, the head of Australian economics at ANZ, wisely reasoned that it was "not really possible for us to 'forecast' when we will be surprised".

"The RBA has substantially revised up its inflation forecasts, which lessens the prospect it will be only surprised to the high side," Plank said.

"But we can't rule this out happening again. We only get quarterly inflation and wages data in Australia so the opportunities for big data surprises are relatively limited."

Indeed, wages may be where the surprise lies, and we won't have to wait long, with the Australian Bureau of Statistics scheduled to release the wage price index (WPI) data on 18 May, only three days before the federal election.

"Expectations on wages growth are still quite muted, and so there is the potential for upside surprises here," said Cherelle Murphy, a senior EY economist who was among the first out of the blocks after the CPI release to call for Tuesday's rate rise.

The government will be among those hoping for a surge in salaries to help counter Labor's argument that "everything is going up except your wages" - with interest rates being added to that mounting pile.

Annoyingly for economists such as Gareth Aird, head of economics at Commonwealth Bank - the nation's biggest lender - it was the RBA's decision to trust relatively ad hoc data on wages that blindsided his team. The CBA was among those predicting the central bank would hold fire on rates until the WPI data landed post-election.

In his media conference on Tuesday, Lowe revealed the bank's scouts had learned about 40% of firms were looking at wage increases with a "three" on them and some had a "four". While shy of the annual 5.1% headline CPI for the March quarter, those increases suggested to Lowe that long-awaited salary increases as the jobless rate sank below 4% might now be arriving.

In a briefing note on Tuesday, Aird said with some angst that "business surveys had for some time indicated that wages growth was moving higher, so it was a surprise that the board only [on Tuesday] decided to put weight on 'unofficial' wages data".

The RBA itself aimed to head off some of the surprises by what Aird described as its "massively upwardly" revision of future headline and underlying inflation. The RBA now expects underlying inflation - its trigger for cash rate moves - of "around" 4.75% in 2022, compared with its most recent forecast in the Statement on Monetary Policy from February of 2.75%.

The adjustment of two whole percentage points for a year more than a third of the way in is "a radical revision" and means "the RBA has completely changed their view on the outlook for inflation", Aird said.

While prime minister Scott Morrison tried to trumpet the rate hike as proof of Australia having avoided the fate of nations such as New Zealand and the US where inflation is running in the order of 7-8%, it seems more that the RBA has its work cut out heading off such levels. In fact, Australia's exceptionalism is fading.

Another surprise, then, may come in the as-yet unknowable pace the RBA is forced to raise rates and for how long. As Lowe outlined, nobody can predict with confidence how Russia's war in Ukraine or China's battles to maintain its zero-Covid policy will fare, both of which carry big implications for commodity prices, among other things.

Lowe indicated that "normal policy" would see the cash rate rise to 2.5% even though investors were predicting even before Tuesday that level would be reached by the end of this year, on the way to 3.3% by May 2023.

The major banks, though, are not in that league of worry just yet. NAB, for instance, expects "steady" rises for the rest of this year, with three more in 2023 and two in 2024 until the cash rate peaks at 2.6%.

The ANZ expects the RBA to reach 2.5% by mid-2023 and eventually lift it to "3-point something, albeit not for some time". CBA's Aird sees 25 basis points rate hikes in June, July, August and November this year and for it to reach 1.6% by February and staying put until the following year.

Rising interest rates, of course, will add strains to many household budgets. Morrison put Tuesday's toll at about $80 a month for the average mortgage holder, a figure that will swell by each quarter-point rate rise to come.

Could that stress turn a plateauing of property prices into a rout?

Brendan Rynne, a senior KPMG economist, said gloom in the market is "unlikely", not least because the jobless rate is low and falling, and some wage increases will come after the new financial year starts in July.

Also, as Lowe also pointed out, homeowners have used much of their $250bn or so savings hoarded during the Covid panel to get further ahead on their repayments.

"A lot of Australians have been very cautious and have built up cash buffers," Rynne said. "But not everyone" - and those borrowers will have to be watched carefully.

Tim Lawless, the research director of CoreLogic, said housing price growth rates had already been losing steam, particularly in Sydney and Melbourne, and would trend "into negative territory due to factors including affordability constraints, higher fixed term mortgage rates and lower levels of consumer sentiment".

Some of that consumer confidence is already waning, with the ANZ's weekly survey finding sentiment is slumping at the fastest pace since January.

"Past research from the RBA has pointed to 'high end' housing markets with higher investor concentrations being more sensitive to changes in interest rates in the short term," Lawless said.

Just how sensitive may then be among the surprises to come as the RBA cranks up its rate-rise machine.