RBA rate hikes spread costs across the economy
RBA rate hikes spread costs across the economy as traders expect a fifth consecutive increase, impacting home loan repayments and easing inflationary pressures.
Traders now expect the Reserve Bank of Australia to implement its fifth consecutive interest rate increase next week. Regardless of timing, observers will closely watch how rising borrowing costs affect home loan repayments. However, this is only part of the story—higher rates influence spending across the entire economy, playing a key role in easing inflationary pressures.
Stubborn inflation persists
For nearly five years, inflation has consistently exceeded the RBA’s 2-3% target band. New figures released this week confirm the trend, with annual inflation climbing to 4.3% in September, up from 4.0% in August. Even the RBA’s preferred underlying inflation measure, 3.7% in the September quarter, remains significantly above the central bank’s desired range.
RBA leaders have grown more insistent about the urgency of taming inflation. Deputy Governor Andrew Hauser recently cautioned that current projections are far worse than those outlined in August’s report. He also expressed concern that growing numbers of businesses doubt the central bank’s resolve to meet its inflation goals, describing the situation as a ‘central banker’s nightmare.’
Assistant Governor Sarah Hunter addressed the bank’s strategy on 60 Minutes, stressing that ‘higher interest rates will work.’ The RBA’s standard approach to cooling inflation involves raising rates to curb economic activity. Still, public skepticism, possibly held by a majority, questions whether this method will deliver the intended results.
The cash flow channel
Should the RBA increase rates again, the spotlight will likely land on the roughly one-third of households carrying mortgages, especially those in cities with the highest property values. Struggling with raised repayments, these families will have fewer funds available for other purchases, a phenomenon known as the ‘cash flow squeeze,’ which grabs attention due to its immediate impact.
Yet this effect represents just one pathway, and its influence may be limited. Some households, like retirees, actually gain from higher savings interest. Beyond mortgage pressures, broader economic effects include increased saving and reduced spending, which ripple through the community beyond homeowners.
Raised borrowing costs extend to all debt types, making loans for cars, appliances, and furniture less appealing, delaying such purchases. Businesses, too, may postpone investment plans when financing becomes more expensive.
Higher rates also reduce asset values, including stocks and real estate. By mid-2026, property prices in Sydney and Melbourne had dropped by 5%, leaving households feeling less financially secure and more reluctant to spend.
New RBA analysis suggests the cash flow impact, particularly from mortgages, has a modest effect, while the exchange rate plays a far more significant role.
RBA Governor Michele Bullock commented that the most important channel is the exchange rate channel, Hauser has gone further, calling the exchange rate channel by far the most important in Australia.
Exchange rate effects
Because the impacts on the exchange rate are less visible to households, they also receive less attention, but they are still helping to slow the economy, and combat inflation.
A stronger dollar makes imports less expensive for Australian consumers, directly lowering prices, a stronger Australian dollar can also weaken domestic economic activity.
The trade-weighted index, which measures the Aussie dollar against a basket of currencies, is at 65, up from around 60 during 2025, the Australian dollar has appreciated from 67 to 70 US cents.
The RBA has done modelling that shows the peak effect of a rate move on economic activity and inflation occurs around one to two years after the rate change, the models suggest real gross domestic product could be 0.4% to 0.5% lower.
Higher interest rates have damaging side effects, one of the ways in which higher interest rates slow the economy is by deterring, or deferring, some business investment, unfortunately, that could also be making Australia’s productivity performance worse.
As higher interest rates slow the economy, unemployment rises, the unemployment rate has risen from 4.3% in February to 4.7% in September, the Reserve Bank will be hoping it can get inflation back within its target band fairly quickly.
