Economic update – The coming peak in interest rates may be masking vulnerabilities

Talking points:

  • The Reserve Bank of Australia (RBA) has increased interest rates substantially over the past twelve months and is within sight of the finishing line.
  • Australia’s labour market has been strong, which has prevented a slump in spending.
  • Inflation remains sticky due to rising prices in the services sector. Hence, official interest rates are unlikely to decline this year without a recession or a destabilising event.
  • A few big tech names have driven US sharemarket performance, with gains across the ASX also narrowly based.
  • The US debt ceiling looks to be resolved, but economic and market risks are mounting.


As we near the end of the financial year, share markets have shown considerable resilience in 2023. Despite numerous calls in the financial media of an impending recession and a housing market crash, there have been very few signs since Christmas. Ongoing supply constraints and record levels of net migration have combined to propel housing prices modestly higher in the first half of this year. In addition, a tight labour market has seen workers maintain high levels of job security, largely offsetting the impact of higher interest rates on consumer confidence.

However, the elephant in the room is persistently high inflation. The monthly CPI accelerated in April, driven by rising rents, a lift in holiday travel costs and higher transport prices, following the unwinding of the temporary cut in the fuel excise last year. The good news is that inflation is well below the peak in December, and the annualised increase over the previous few months is within arm’s length of the top of the RBA’s target band.

If wage growth remains moderate, or there is an improvement in productivity, then the RBA cash rate is unlikely to rise to the levels seen in places like NZ, the US and the UK. Domestic interest rate expectations have recently increased, but the peak should remain below 4.5%. While the lagged effects of sharply higher interest rates place Australia at greater risk of entering a recession in 2024, investors are currently taking their lead from US markets.

The strength of the US economy in 2023 has surprised most analysts, culminating in a shallower decline in company earnings. Outside of the banking crisis in March, shares have moved higher, with returns dominated by large-cap tech stocks. However, the consensus across markets and economists is that the US will experience some kind of recession later this year.

After much back and forth, the Democrats and Republicans agreed to suspend the debt ceiling until after the 2024 presidential election, thereby avoiding a catastrophic default. While this is welcomed news, the deal’s timing may prove to be a curse in disguise. It will allow the US Treasury to issue new debt and spending programs to continue. But, perversely, new bond issues will soak up a key component of market liquidity simultaneously as the US Federal Reserve shrinks its balance sheet, leading to much tighter financial conditions and higher volatility.

Meanwhile, personal savings have moved lower just as credit conditions are squeezed. If the banking crisis again rears its head over the coming quarters, it could lead to a credit crunch and bring about the economic hard landing markets are not currently positioned for. And given the narrow base of share market gains in 2023, investors appear increasingly vulnerable to a sharp sell-off and would be wise to stay vigilant.

Our experienced financial planners provide tailored strategies and guidance to suit your unique needs and financial goals. If you’re seeking expert financial advice, book a chat with a Pekada financial planner today.