A higher-than-expected inflation result both domestically and in the United States, coupled with rising bond yields, sent the Australian share market into sharp decline in the month of January. The All-Ordinaries index closed the month 6.6% lower at 7,268.3 points.
Global share market results were mixed in January, with the United States Dow Jones index falling by 5.4%, the London FTSE gaining by 1.1%, the Japan Nikkei 225 falling by 6.2% and the Hong Kong Hang Seng Index gaining by 1.7% for the month.
The Australian Dollar was under pressure in the month, with one Australian Dollar currently buying 70.69 United States cents (down 1.5% for the month and was as low as 69.88 United States cents late in January).
The Reserve Bank of Australia (RBA) did not meet in January and are due to meet today. For the year to December, the Australian inflation rate increased to 3.5% which was above expectations, and above the RBA medium term target range of 2% to 3% per annum inflation.
The December quarter inflation result has caused immense speculation that the RBA board will be increasing interest rates far sooner than their previous guidance of 2024. While no increase in the official Cash Rate of 0.1% per annum is expected at today’s RBA’s announcement, it will be important to view the RBA board meeting minutes for any change in their guidance.
As a core principle, a central bank increasing interest rates is usually a good sign that economic fundamentals are in order. Nevertheless, interest rates are at unprecedented low levels (deposit rates were closer to 10% per annum last time Australia experienced high inflation in the 1970’s). Therefore, it remains to be seen exactly how asset values will react to any increase in interest rates.
For what it’s worth, my view is that the RBA will not be able to increase interest rates at anywhere near the same level as the United States Federal Reserve for one simple reason – the Australian consumer has more household debt!
The chart below compares both Australian and United States Household debt to GDP ratios.
Source: Trading Economics
As shown above, the Australian consumer since the early 2000’s has a held a higher level of debt relative to the size of the Australian economy. Indeed, Australian households have continued to increase their level of debt relative to the size of the economy throughout the last decade, to a point now whereby Australian household debt to GDP ratio is some 52% higher than that of the United States!
Given the above, in my view, if the RBA board were to increase interest rates at the same pace as the United States Federal Reserve, then the Australian economy will be impacted to a much greater degree – as Australian households carry a higher level of debt. This must be unlikely given the support that the RBA have provided the economy through the COVID downturn.
Consequently, I do expect the United States Federal Reserve to increase interest rates in the United States sooner, and at a swifter pace, than the RBA in Australia (and this is largely ‘factored into’ asset values already). However, I do not subscribe to those that are predicting the RBA will increase Australian interest rates as early as May this year.
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This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.