Will the RBA raise interest rates during the election?

Could the Reserve Bank of Australia be a surprise, last minute entrant in the federal election race?

It has gone from a very remote possibility to a real threat with the March quarter CPI figures out this Wednesday potentially ramping up pressure for an official rate rise at the RBA’s 3 May board meeting.

As a body that prides itself of being independent of political pressures, the RBA nonetheless tries to avoid becoming part of the election campaign, but it will not hesitate to act if the board believes the inflation picture is worsening faster than expected.

They also would have noted the US Federal Reserve Chair Jerome Powell’s increasingly urgent warnings that rates will rise quickly in the United States – another factor that feeds into the global inflation and interest rates scenario.

John Howard’s experience could be repeated

The most famous RBA intervention into an election campaign was in 2007, when the bank raised rates by 0.25% to 6.75% on 7 November – something that fed into but didn’t cause John Howard’s landslide loss to Kevin Rudd on 24 November.

In many ways a rate rise in this election would be even more significant, given the high level of household debt and the sensitivity of millions of households to housing interest rate rises which would follow on from any RBA hikes.

While interest rates are currently at record lows, that makes any rises particularly difficult to deal with and could increase mortgage stress quite quickly.

Is a super-sized rise a chance?

That would particularly be the case if the RBA went for a larger than usual rate rise, with some pundits such as Westpac’s chief economist Bill Evans tipping that when the RBA does move it will go for a rise of 0.4% on the current 0.1% to take official rates to 0.5% in an attempt to head of inflationary pressures and get ahead of the curve.

Financial markets are now saying a May rise is a flip of the coin proposition which also presents the possibility of a more gradual rise to 0.25%, but a super-sized rise would have significant ramifications given Prime Minister Scott Morrison’s claims of superior economic management.

In looking at the issue, the RBA board which has so far been relatively dovish about raising rates, would be aware of the dangers of waiting too late to remove super-stimulatory interest rates and also of the advantages of a larger than usual rate rise shock as a way to show its determination to head off inflationary pressures and potentially avoid future rises.

Waiting until June is still likely

Having said that, there is also a good chance the RBA will wait until June to move, which was the conventional wisdom in markets before the latest round of pressure in the form of the US Fed comments and the IMF report, which sounded a dire warning about the sustainability and cost of Australia’s massive foreign debt pile.

Westpac’s Bill Evans said the move for a bigger than usual rise was driven by “our expectations of a rapid further increase in underlying inflation and a forecast fall in the unemployment rate for April to a 48-year low of 3.8%’’.

A full pass on of a 0.4% rise would raise repayments on an average $800,000 mortgage by $168 a month, although the plethora of fixed housing loans would reduce the spread of such an increase.

Nevertheless, rising rates would still deliver a significant future shock to those on fixed rate loans when it came time to renegotiate a new loan at the end of the term.

These rises would not be in isolation either, with many banks now forecasting that the RBA cash rate will be anywhere between 2.25% and 3.5% by the end of next year.

Rising rates will cause budget pain

The other significant cost of rising interest rates will be felt directly on the federal budget which is facing the prospect of steeply rising interest rates on the record amount of debt, which is heading inexorably to $1 trillion.

While many of these debts are funded by existing bonds with tiny interest payments, these will increasingly need to be refinanced over time, adding billions of dollars to the cost of servicing the record amount of Federal Government debt, which is now sitting at a record gross $889 billion.