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[HSC] Economist: 13th June

A summary of this fortnight's economics news: interest rates and recession!

Zack Bolland

Zack Bolland

99.80 ATAR, Dux, 8th in NSW for Econ

Well, it certainly has been an interesting two weeks. The US announced an extraordinarily high CPI rate of 8.6% for March, England is about to raise interest rates, the Australian and US markets have tumbled amidst fears of persistent inflation, and banks across the globe are losing money by the minute. Bitcoin, alongside other cryptocurrencies, has also fallen by 19.48% over the past 5 days (it fell by 2% whilst I was writing this article). Whilst some are scared about burgeoning inflation levels and the inordinately high price of lettuce in Australia (which will be discussed later on), others are directing their attention to a future recession. Jamie Dimon, the CEO of JPMorgan Chase, stimulated investor and consumer confidence (not) when he said that we should “get ready for an economic ‘hurricane’” last week. And if that wasn’t enough news for you, the RBA also announced a significant increase in the cash rate by 0.5% on the 7th of June. This fortnight’s article will focus on the RBA’s significant decision, the food shortages sweeping the nation and the impending recession that major players across the globe can’t seem to get enough of. 

The cash rate hike and the significance of the RBA’s bold decision

As mentioned earlier, the RBA announced a significant, albeit unexpected, increase in the cash rate by 0.50%. The cash rate increase beat the expectations of many of Australia’s leading economists, like ANZ’s Head of Australian Economics, David Plank, who predicted a mere 0.15% increase. Plank also expects the cash rate to reach 2% by the end of 2023, however, given the size of the latest interest rate hike, it is highly likely that the RBA will surpass that 2% projection in no time.

The increased cash rate is a direct response to the above-target rate of inflation (5.1% for the March Quarter, 2022) currently suffocating many sectors of Australia’s economy at the moment. Whilst Phillip Lowe did note that “inflation is lower than in most other advanced economies”, the inflation rate is beating expectations left, right and centre. Our goal of 2-3% inflation has remained in place since the early 1990s when the RBA introduced their esteemed inflationary targeting framework, meaning the RBA has every right to increase the cash rate dramatically.

So who will be affected the most by this decision? Homeowners. When the cash rate rises, it costs more to borrow from banks. This is because a higher cash rate translates to higher interest rates, as commercial banks are concerned with maintaining profit margins, meaning your average homeowner has to pay additional interest on their mortgage repayments. The Sydney Morning Herald estimates that a homeowner with a mortgage in NSW of $800,000 on a 25-year loan faces an increase of $320 a month due to the recent cash rate change.

The high rate of inflation is driven by supply-side inflation, with China’s COVID-19 lockdown situation and the Russia-Ukraine War driving up inflationary pressures worldwide. Therefore, many have questioned the response of the RBA, as cash rate changes primarily influence aggregate demand and thus may be unable to appropriately tackle high inflation. Yet, we have already seen the profound effect that the previous 0.25 basis point hike has had on Australia. Sydney housing values have fallen by 1.5% and property values nationwide fell by 0.1% for the first time since September 2020. Moreover, AMP Chief Economist, Shane Oliver, argues that inflation will reach 7% in the second half of 2022 and thus, it will become extremely difficult to reduce inflation at that point without causing a nationwide recession. Whilst we won’t see the full effects of the RBA’s decision until late 2022 (due to the associated time lag), the decision is certainly justified.

Why there may be a recession soon

Speaking of a recession, there are growing concerns that one may be on the horizon in the next few months. Following the cash rate hike, the big four banks suffered significant losses; ANZ fell by 2.3%, NAB fell by 3.9%, CBA fell by 4.4% and Westpac fell by 6.1%. This is extremely concerning, as banks typically make a profit when the cash rate rises, as they are able to maintain higher profit margins and thus, perform better overall. This was noted in a recent ABC article, which found that Australia’s big four banks (ANZ, CBA, NAB and Westpac) now hold $1.87 trillion in home loans, as house prices skyrocketed and Australian citizens kept on taking larger mortgages to counter the price rises.

If the banks are taking losses, it means that investors are expecting something bad to happen (i.e. a recession). Lower borrowing means investors are attempting to minimise risk, save money and prevent themselves from falling into a debt-trap cycle. Since it has only been a few days since the RBA made their decision, we cannot assess whether this trend in equity markets is a direct response to the cash rate change or perhaps a response to generally high inflation rates across the globe. Notably, US inflation just hit a 40-year high of 8.6%, which has led to significant downturns in US markets. This has the potential of having a contagion effect across the globe, which Jamie Dimon notes is a possibility, after telling investors to “brace themselves for an economic hurricane”.

Why does my Zinger Burger have cabbage in it?

On a lighter note, you may have noticed the price of lettuce rising dramatically. The price of iceberg lettuce reached a high of $12 in a Queensland supermarket last week. Farmers across Australia are struggling to obtain stock, as freezing temperatures set in and farmers are unable to plant more lettuce, despite losing stock due to wet weather in Queensland. Whilst this has major short-term implications for lettuce-lovers, farmers are expecting lettuce prices to fall back down and for lettuce stock to return to normal soon. Some are even joking that this will make people more enthusiastic to buy lettuce after prices fall back down.

KFC advised its customers that they are currently using a blend of lettuce and cabbage in stores across Australia’s eastern states due to the supply issues noted above. Now, you can remove vegetables from your beloved KFC treats to avoid the controversial cabbage-lettuce blend. It is hard to estimate how long the shortfall of lettuce will last, and some AusVeg spokespeople have even gone as far as to say that it could be a while before prices drop. KFC customers won’t be too happy to hear that, but hopefully lettuce stock can return back to normal soon enough.

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