Besides the pending May 21 elections in Australia, much of the Western media over the last few months has been focussed on the events in the Ukraine, given both the human devastation as well as economic impact that the conflict has inflicted.

Given that many European countries rely heavily on the supply of natural gas and oil from Russia to fuel their energy needs, this situation has had a major impact on energy prices in many countries and is now also impacting other commodities that come out of both Russia and Ukraine. In a global economy where prices are determined on a supply and demand basis, the price of oil, coal, gas, agricultural products, and other commodities and has risen sharply in recent months.

This by itself is a major contributor to global inflation, but when we couple this with the supply constraints caused by Covid lockdowns on almost all goods imported from China and other developing countries, you have a recipe for much higher inflationary pressure.

To try and counter this inflationary pressure the Federal Reserve in the US, along with many other central banks have aggressively started to raise interest rates in an effort to curb inflation. Not since 1982 has inflation reached these levels and so it is no surprise that they have taken this approach.  Inflation in Australia has gone above 5% and is forecast to hit 6% by year end.  Australia, like the US, Canada, NZ, Europe and most other developed countries is not immune from these international pressures and therefore rising interest rates are inevitable in this country, regardless of the May election outcome.

The question now is how far the cash rate will go up and what implications that will have on mortgage rates and ultimately house prices, as well as the broader share market.  The RBA has already raised the cash rate by 0.25% to 0.35% and economists are now predicting that this may peak at around 2% in 2023.  This would translate to potentially a 2% rise in mortgage rates from current levels of between 2-3%.  Whilst this may sound low to many borrowers who witnessed rates of up to 18% and more in the late 80’s, it does translate to an additional $1000pm interest bill given the size of the average mortgage has now risen above $618,000.

Consequently, many economists are predicting a fall in house prices between 10-15% over the next two years. Given the sharp rise over the last few years this scenario is entirely feasible and should provide some relief for first home buyers. Those who follow share markets more closely would have seen increased volatility in recent months with some sharp falls in recent weeks. This has been particularly evident with growth stocks. The Tech heavy NASDAQ index is down 23% for the past 6 months after the sharp rise last year.  Whilst higher inflation and interest rates have had a negative impact on most share prices there are exceptions, particularly those companies in Australia who are benefiting from the supply shortages in Europe.

In summary, higher inflation and interest rates are here to stay for a while yet and whilst this may not be a good thing for those with large borrowings it does mean that returns on cash will improve, albeit from a very low base.  Also, whilst it may take some time for share markets to adjust to the new norm it does not necessarily mean that share markets will not perform.  There is plenty of history to suggest that markets can perform in an environment of rising interest rates providing this is measured and results in a soft landing rather than a full-blown recession.

Important: This email has been prepared for the purpose of providing general information only, without taking into consideration your objectives, financial situation or needs.  You should therefore consider seeking professional advice, having regard to your personal circumstances before making any investment decisions. Whilst every care has been taken in the preparation of this information, neither Quill Group or any staff member makes any warranty or representation as to the accuracy or completeness of any statement contained in this article.