Australia’s central bank could increase interest rates eight times in the next two years, former board member John Edwards said.

The Reserve Bank is probably already considering a program of rate increases given its forecasts for inflation returning to target and economic growth to accelerate to 3 per cent against a stronger global backdrop, Edwards said in a column on the website of the Lowy Institute for International Policy, where he is a non-resident fellow.

Theorising that the long-term cash rate is about 3.5 per cent — lower than the 5.2 per cent average over the past two decades — and the RBA wants to start tightening in 2018 and reach its goal within two years, that would require four quarter-point increases each year, he said. Rates have been on hold at 1.5 per cent since last August.

“It seems to me that something like eight quarter percentage point tightenings over 2018 and 2019 are distinctly possible, if the RBA’s economic forecasts prove correct,” said Mr Edwards, who was on the bank’s board until July last year.

“It’s possible the tightening could start earlier, or if not the tightening itself, at least the signalling which should precede it. We may be seeing a little of that now.”

Small Steps

The RBA traditionally makes small steps and typically doesn’t commit itself to subsequent moves, making the market wary of predicting where the bank will be in a few years, Edwards said.

In the current circumstances, he said we could reasonably assume:

The RBA considers its current rate to be exceptionally low;

If the economy improves as it predicts, the next move will be up;

If the economy was operating, as the RBA predicts, at 3 percent output growth and 2.5 percent inflation, it would think of a sustainable or natural policy rate of at least 3.5 percent;

Most importantly, it will want the policy rate increase to match the forecast improvement in Australia’s economic performance, so rising to at least 3.5 percent by the end of 2019.

Mr Edwards noted the risks of rate increases alongside high household debt, with most Australian mortgages on variable interest rates closely tied to the RBA’s cash rate.

“The bigger the household debt, the more impact a quarter percentage point increase in the policy rate will have on household spending,” he said.

“In the Australian case, it is certainly possible that high household home mortgage debt will crimp consumer spending if the policy rate returned to what was once considered a relatively low long-term rate.”

Still, Edwards noted, interest paid on Australian mortgages is much less than it was six years ago: while debt has increased, interest rates have fallen a lot. Payments are now 7 per cent of disposable income compared with 9.5 per cent in 2011, and 11 per cent at the peak of the RBA tightening cycle before the 2008 financial crisis, he said.

Moreover, if the standard variable mortgage rate peaked at around 7 per cent, that would still be nearly one percentage point below the 2011 level, and two-and-a-half percentage points below the 2008 peak, he said.

“The pace of tightening will anyway be governed by the strength of the economy,” Edwards said.

“If household spending weakness, if the long expected firming of non-mining business investment is further delayed, if the Australian dollar strengthens, if employment growth is persistently weak, then the trajectory of rate rises will be less steep and the pace less rapid.”

This story was first published by Bloomberg