Anneke Thompson, Chief Economist at CreditorWatch, comments on today’s cash rate decision. This is in response to last week’s increase in annual inflation seeing it at its highest level since the introduction of the GST in 2001.

The Reserve Bank of Australia (RBA) has once again decided to raise the cash rate target by 50 basis points, taking the official cash rate to 1.85 per cent. This is the fourth month in a row that the RBA has chosen to increase, indicating the level of concern that inflation is causing. Contributing to the decision was July’s employment data which saw the unemployment rate drop to 3.5 per cent. There are now 600,000 more Australians employed than there were in March 2020 – an extraordinary increase.

The economic update provided by the Treasurer last week pointed to inflation peaking toward the end of the year, at near eight per cent, before starting to fall in 2023. While this is clearly of concern, the RBA will no doubt be focused on trying to break out supply side inflation, versus the demand side, and tailoring their monetary policy response as close as possible to this.

Much of the inflation recorded over the June 2022 quarter was caused by supply side issues – the war in Ukraine (fuel), and weather events (fruit and veg). Construction of new dwellings was another big contributor to inflation, driven by both demand and supply issues. It could be argued that the forward demand issue here has already been resolved through falling house values and dramatically increased construction costs, which will deter buyers from starting new homes and renovations.

Further, whilst Australia’s inflation number is double the upper range of the RBA’s target, it is far below that of other western nations, suggesting that maybe the RBA caught the cycle earlier than other countries’ central banks. Quarterly inflation was also lower than the March quarter (1.8 per cent vs 2.1 per cent in March), which means price rises at least aren’t gaining momentum.

For businesses, inflation and interest rate rises continue to cloud the operating outlook. CreditorWatch’s June BRI probability of default (POD) data forecasts a significant one 1 per centage point rise in the rate of defaults by SMEs over the next year. Those businesses that are most reliant on discretionary spending (food and beverage and arts and entertainment) are the most at risk.

In terms of geographical areas, our highest PODs by SA3 tend to be clustered in areas where there are high mortgage rates and where many homes were sold in the last few years. This includes the likes of Auburn (NSW) and Surfers Paradise (QLD) These borrowers are most impacted by rising interest rates, and for SMEs, this flows through to business defaults.

While it’s highly likely that the cash rate will rise further, this assumes that supply side issues can begin to resolve themselves. Unfortunately, luck and other factors outside the control of the RBA will tell the story there.