RBA review explained – why it matters for you

The Reserve Bank of Australia is about to be examined in great detail after the federal treasurer announced a long-awaited review into the central bank.

The first major review of the RBA in decades coincides with one of its most aggressive interest rate hiking cycles on record, as the central bank tries to get soaring inflation under control.

Since May, the RBA has lifted interest rates from a record low of 0.1% to 1.35%, and economists at ANZ and Westpac expect the cash rate will reach above 3% by the end of 2022.

That’s despite the RBA repeatedly telling households last year that interest rates were expected to remain on hold until at least 2024.

The RBA has been criticised for telling borrowers interest rates weren’t expected to rise for years. Picture: Getty

However, Treasurer Jim Chalmers stressed the review isn’t about taking ‘potshots’ at the RBA.

“I don’t want it to be exclusively focused on a backward looking blame-shifting exercise,” Dr Chalmers said.

“My focus is primarily forward-looking. I don’t want this to be all about taking potshots at the governor or the board.

“I don’t want it to be primarily about second-guessing decisions that the board has taken, particularly in the recent past.”

Instead, he said it’s about ensuring Australia has the world’s best and most effective central bank into the future.

“This is an important opportunity to ensure that our monetary policy framework is the best it can be, to make the right calls in the interests of the Australian people and their economy,” Dr Chalmers said.

The review will look into the RBA’s objectives, mandate, the interaction between monetary, fiscal and macroprudential policy, its governance, culture, operations, and more.

RBA Governor Philip Lowe has welcomed the review. Picture: Getty.

If you’re wondering what that means in layman’s terms, you’re not alone.

Attempting to break it down, one of the country’s top economic analysts, Warren Hogan, says the review is about fine-tuning how the RBA works.

“It’s a health check on how they go about their monetary policy and setting interest rates,” Mr Hogan said. “There’s a lot of issues, but they’re quite detailed.

“They’re sort of issues that us economics nerds are going to have a big fight about over the next year and some of us will be happy and some of us will whinge when the findings are done.”

While the issues are complicated, Mr Hogan says it’s possible the final outcome could mean lower interest rates for mortgage holders. We’ll explain that a little later.

But first…

Why is there a review?

Soaring inflation, high interest rates and the cost of iceberg lettuce have dominated news headlines over the past few months, but that’s not why the federal government announced the review.

The RBA will undergo its first major review in decades. Picture: Getty

For a start, the review was an election commitment made by both major parties prior to the May federal election. It was also a long time coming.

“The review is actually just something that should be done periodically,” Mr Hogan explains.

“And when I say periodically, the last review was done 40 years ago, the last major sort of change in the way the RBA went about its monetary policy, that is setting interest rates, occurred 30 years ago.”

And that’s when the RBA set its inflation target of 2-3%. The RBA now expects inflation to reach above 7% by the end of 2022.

“[The review] is definitely not being triggered by any particular event, whether it’s the higher inflation that we’re seeing now or the very low inflation that we saw prior to the pandemic,” Mr Hogan said.

“Or indeed, what the RBA did through the pandemic with some of their extraordinary unconventional monetary policies.

“Although all of these things will end up being part of the review.”

How could it impact mortgage holders?

A lot of issues will be examined in this review, but the most important one for mortgage holders will be whether the target inflation range is still appropriate 30 years after it was set.

The RBA’s 2-3% inflation target will be under review. Picture: realestate.com.au

Mr Hogan explains the 2-3% target inflation range implies a target inflation rate of 2.5%, whereas most other advanced economies target an inflation rate of 2%.

“So the question they’re really putting forward is, why are we different? Why are we targeting higher inflation? Which of course implies higher interest rates over the long term,” Mr Hogan explains.

“I think the reasons they did target 2-3% [inflation] 30 years ago were fine but I just don’t think they apply anymore.

“So I suppose you could argue that if the inflation target is brought into line with the rest of the world, and I would suggest that means a target of 1-3% not 2-3%, mortgage holders could expect over the long term, and I’m talking about the next 10 years, to have slightly lower interest rates on average than if it was at 2-3%.

“Literally, half a percent lower, but that’s really the extent of the implications for mortgage holders.”

But Mr Hogan said mortgage holders shouldn’t let those potential rate cuts impact decision-making today, because any changes would play out over the next decade or so.

The review findings will be handed to the government in March next year, and Mr Hogan says it’s unlikely any findings would be implemented until late 2023 or 2024.

The governor of the RBA, Philip Lowe, said he looks forward to participating in the review process.

“It is an opportunity to take stock of our monetary policy arrangements and make sure that they are fit for purpose for the challenges ahead,” Mr Lowe said.

“We look forward to participating in this process and listening to and learning from others.”