Understanding Interest Rates & the Current Economic Climate; Will There be Further Rate Cuts?

Posted by Ali Alzedan

When the Reserve Bank of Australia (RBA) announced its first cash rate drop since November 2020, 25 basis points to 4.10%, a wave of speculation swept across the Australian property market, bringing uncertainty and hesitation. The big question now is whether this was a one-off sigh of relief or the beginning of a long-term easing cycle.

Uncertainty is mounting with the next RBA board meeting scheduled for Tuesday, April 1st. Investors, homeowners, and financial institutions are eager to discover what lies ahead. Big banks are scrambling to forecast the RBA’s next steps, adding to the confusion that is already gripping the market. So, let’s break it down.

What Are the Big Four Banks Predicting?

The major banks differ in their forecasts of the RBA’s future decisions. ANZ is taking a more cautious and conservative stance, predicting only one more rate cut this year, likely in August, which would bring the cash rate to 3.85% by the end of 2025.

In contrast, The Commonwealth Bank, NAB, and Westpac are more optimistic, each expecting a rate cut every quarter for the remainder of the year, forecasting the cash rate to drop down to 3.35% by the end of 2025. These banks believe continued inflation moderation and broader economic data will support the additional easing of interest rates.

What Does Economics Say?

Historically, interest rates have been the primary tool used by central banks to control credit and lending. This drives the short-term debt cycle, which typically lasts five to eight years. By understanding how interest rates are used to control borrowing and spending, we can forecast the RBA’s next big move.

The short-term debt cycle spans three different phases;

Low interest rates
Increasing interest rates
The beginning of interest rate cuts.

Phase 1: Low interest rates (2019 – 2022)

In this first phase of the short-term debt cycle, interest rates are lowered to encourage and increase borrowing. Borrowing becomes cheap for individuals and businesses, and people are more motivated to take on debt to fund their purchases of properties and cars or simply take out a loan to renovate their homes. This is due to the price of money being viewed as ‘cheap.’ More borrowing results in more spending, and one person’s spending is another’s earning. Reserve banks lower interest rates in this period to encourage economic growth in a slow economy. Think of this period as 2019-2020, interest rates were at an all-time low due to the global pandemic (0.10%). Property prices were booming, and overall spending was encouraged by the government through different grants, such as Job Keeper and Job Seeker.

Phase 2: Rapid expansion, Interest Rates Peak (2023-2024)

With high spending levels, The RBA then raises interest rates to prevent the economy from overheating.

When the economy grows rapidly, inflation begins to increase, as we saw in December 2022, when the RBA reported inflation to be 7.8%, the highest it has been since September 1987. This rapid increase in inflation is directly attributed to the rapid economic growth that has been promoted by continuous government grants and low interest rates in previous years.

As interest rates continue to climb, existing debt taken on by businesses and people becomes more costly to pay off. We saw this from May 2022 to November 2023 as the cash rate climbed from 0.1% to 4.35%. This means there is less money to spend on purchases of goods or expansion of businesses. This slows economic growth, and the economy begins to decline. This brings us to the peak of the short-term debt cycle. The high interest rate is maintained until inflation declines and more stability is achieved in the market.

Phase 3: Interest Rate Cuts Begin

Once inflation and unemployment are under control, the government and central banks respond to the slowing economic growth by beginning to lower interest rates. By making debt cheaper and increasing the borrowing power of individuals and businesses, this encourages the market to take on debt again, which results in an increase in spending. If successful, this begins the next economic expansion phase, and the cycle begins again.

Are we in Phase 3? Where is the Australian Economy Headed?

With unemployment at 4% and inflation at 2.4% (perfectly within the RBA’s target range of 2-3%), it is safe to say we are at the beginning of phase 3 in the short-term debt cycle. This is the time we see reserve banks slashing interest rates, which began with a 0.25% cut in February.

If history is any indication, we will continue to see further rate cuts. Three out of the big four banks predict one rate cut per quarter over the course of 2025, bringing the cast rate down from 4.1% to 3.35%.

Posted by Ali Alzedan, on 1st Apr 2025