Why should the RBA take a dovish approach?

The Federal Reserve raised rates by 0.75% last week but there are five reasons for Australia to take a dovish approach, according to Shane Oliver.

US rates were raised by 0.75% which brought the Fed funds rate to a target range of 3%-3.25% and was the third consecutive rise of 0.75%.

However, Oliver, chief economist at AMP, said he did not believe the Reserve Bank of Australia should take a similarly hawkish approach.

The five reasons for this were:

• Household debt to income ratios in Australia are almost double US levels – at 187% in Australia v 102% in the US.
• Household debt interest costs in Australia are far more responsive to rising interest rates – as most borrowers are on variable rates tied to the RBA’s cash rate and the rest are on relatively short dated fixed terms many of which mature next year in contrast to the US where most mortgages are 30 year fixed so only new borrowers are impacted by rising rates. Combined with the first point this means that a given sized rate hike in Australia will be more potent in slowing consumer demand than in the US.
• Inflation is lower in Australia, at least for now.
• Wages growth – the biggest single driver of business costs - is running around half what it is in the US.
• The Fed risks overtightening and causing a serious recession in the US and there is no logical reason why the RBA should do the same.

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He felt a 0.25% rise at the October meeting would be the best option, after its 0.5% rises in June, July, August and September.

Oliver said: “In short, the combination of Australian households being far more vulnerable and hence responsive to rising rates than US households, lower inflation pressures in Australia and a desire to avoid overtightening means that RBA should not raise rates as aggressively as the Fed.”