Why inflation and economic growth hold the key to interest rates

One of Australia’s leading economists has forecast that “ideally interest rates will start to plateau sometime in the first half of the year”.

Ray White chief economist Nerida Conisbee, in making her forecast, highlighted the link between interest rates, economic activity and inflation.

The main reason the Reserve Bank has been pushing up the cash rate since May 2022 has been in a bid to reduce inflation to its target of between 2% and 3%. The idea is that increasing the cost of borrowing will slow the economy, which will reduce demand and therefore inflation.

Inflation may still be rising – it increased in the latest data release, from 6.9% in October to 7.3% in November. However, Ms Conisbee said “there are clear signs” the economy is slowing, pointing to a reduction in job vacancies and building approvals.

Ms Conisbee noted that fast-rising home building costs have been one of the causes of inflation. Those rising construction costs have, in turn, led to the aforementioned reduction in building approvals. “At some point soon, that will flow through to construction costs, which should start to stabilise in the first half of this year,” she said. 

In other words, building inflation is leading to a reduction in building activity; which is expected to lead to a reduction in building inflation.

“The start of 2023 continues to look challenging with inflation still high and interest rate rises continuing. But with signs that the economy is slowing and other factors driving price growth abating, it is looking that inflation should start to ease soon,” Ms Conisbee said.

“It won’t be a particularly enjoyable start to the year for mortgage holders but ideally interest rates will start to plateau sometime in the first half of the year.”

With interest rates rising, many borrowers are currently refinancing to lenders offering lower interest rates. Call or email me if you’d like to discuss whether you could save by refinancing.