The Reserve Bank of Australia (RBA) released the following Tuesday, which is the 1st Tuesday of every month. latest minutes of its monetary policy meetingThe neutral cash rate was announced as 3.5% This is two points more than the record-low cash rate of 1.5%.

This news caused panic on the markets and caused the Australian currency to surge. However, mortgage holders should not be alarmed according Greg Jericho (an economist at Guardian Australia).

“The RBA might wish to get the cash rate to 3.5% but the economy would have to perform a lot better than it is, and for a long time, for that to occur,” he said.

The inclusion in this month’s RBA minutes of a discussion on the neutral real cash rate was bound to trigger a reaction. “The neutral real cash rate is essentially the cash-rate point above inflation where it is essentially having no impact on economic growth,” Jericho said.  “This is important because it reflects – all other things being equal – whether the RBA is trying to speed up or slowdown the economy.”

According to the RBA’s minutes, the rate was broadly stable until around 2007, but has since fallen by approximately 150 basis points to around 1%. The Reserve Bank is recommending an inflation rate of 2.5%. This would correspond to a neutral nominal interest rate of 3.5%.

This signal was taken by investors as an indication that the Reserve bank would raise rates. The market soared as a result. “Of course the RBA would think the neutral rate is higher than it currently is – we are experiencing record low interest rates, and we have them because the RBA is doing what it can to bolster investment at a time when mining investment is going through the floor,” Jericho said.  

Many mortgage holders are likely to be dissatisfied by the idea of interest rates increasing by two percentage point. Rates rise and the average mortgage rate could rise from 5.25% to 7.25 percent. For a mortgage of $400,000, the increase would equate to paying an additional $522 a month – which could be devastating for some of the most vulnerable households.

As worrying as this scenario would be, Jericho insists it’s not about to happen soon.

First of all, neutral cash rates set at 3.5% don’t surprise me. For most of the past 25 years, the cash rate has been at this level or higher. “Just 10 years ago [a 3.5% cash rate] would have seemed like a rate almost impossibly low and only associated with a recession.”

For the Reserve Bank to get rates down to where they are now, they’ve had to cut the cash rate by a lot more than they’ve had to do in the past. “But that the cash rate is below the ‘neutral rate’ only means that at some point in the future the RBA would like interest rates to rise – should other factors permit. And those factors are not present at the moment,” Jericho said.

The Reserve Bank may raise interest rates slightly due to the recent 3.3% increase in minimum wages. This is still far from a two-percent increase. This is why wage growth must be consistent and strong.

“The reality is the RBA will not shift on rates until wages start rising consistently faster than inflation and when it is confident raising rates will not hurt the grass shoots of economic growth we have recently observed,” Jericho said. “The RBA might want to one day get the cash rate to 3.5%, but at the moment the conditions for such a move look well off into the future”.