Low-interest rates have been a mainstay since the global financial crisis of 2008. When the pandemic hit, Governments pushed stimulus measures through the economy, and central banks reduced interest rates even further. Coming out of COVID, housing market demand was strong, and prices boomed. Still, supply chains remained restricted at the same time, and the problems amplified by geo-political tensions increased input costs. Supply could not keep up with demand to support the recovery, pushing inflation higher and broader than expected for extended periods. Central banks have responded by tightening monetary policy and lifting interest rates to control inflation. But the good news is that inflation is likely to ease.
Inflation in the US has started to decrease from a high of over 9% in June 2022 to 7.7% in October, suggesting that interest rates may not rise as high and as aggressively as expected.
Similarly, in Australia, the Reserve Bank of Australia (RBA) Board raised the cash rate by 0.25% to 2.60% at its October 2022 meeting, a lower increase than many expected. The lower-than-expected rise suggests that inflation pressures, particularly wage growth, will be more subdued in Australia than overseas. Comparatively, Australian households are more sensitive to interest rates, with more than 60% of mortgage variable rate loans. This situation is unlike the US, where most borrowers are on 30-year fixed loans.
The increase in interest rates is starting to take effect, helping to restore price stability. However, in its statement, the RBA said that it would be challenging to return inflation to 2-3% while simultaneously “keeping the economy on an even keel”. It concluded the path to achieving this balance is “a narrow one, and it is clouded in uncertainty”.
In housing, the correction in house prices deepened and broadened across Australia, with capital city prices falling by 1.4% in September 2022, rounding out a 4.3% decline over the third quarter. Housing finance approvals continued to mirror the broader correction, with further declines across investor and owner-occupier loans.
So, where does all of this leave us? Inflation will stay higher for longer than initially anticipated. As a result, interest rates are expected to continue to increase, albeit at a slower pace, with the RBA resetting their view along the journey. Economists predict the cash rate will increase to between 3.10% and 3.85% in the first half of 2023 and then remain stable until early 2024 before RBA policy pivots and interest rates lower in early 2024.
Canstar analysis suggests that a 3.85% cash rate translates to an average variable rate of 6.73%. The difference between a 5.73% variable rate mortgage and 6.73% is $650 per month on a $1 million, 30-year mortgage.
Here are some important things you should consider when it comes to interest rates:
- Generally, your debts should not exceed 35-40% of your assets. There will be exceptions to this with new business start-ups and first-home buyers.
- Review the cost of cash in your business, rates, and the configuration and mix of loans to ensure you are not paying more than you need to.
- If possible, avoid having private debt and business and investment debts. You can’t get tax relief on your private debt.
- Keep an eye on debtors, and don’t become your customer’s bank.