The great interest rate dilemma

The two hottest topics (in the financial world) are inflation and interest rates, so I thought I’d just give a little explainer on what is happening.

The interest rate dilemma:

Only 18 months the Reserve Bank (RBA) was saying they would keep cash rates at close to zero for a couple of more years, but as of last month have reassessed the situation and rates are on the rise. 

Why are they rising?

Inflation (our cost of living) and interest rates are very much intertwined, with the RBA using interest rates as a tool to attempt to increase or decrease our spending activity.    There are a lot of complex factors that go into it, but very simply if inflation is high, the government wants to slow it down and may use rises in interest rates to do so and on the contrary when they want to drive spending and economic growth up, they lower interest rates.

Putting current rates into perspective?

For those of you who have been around a while, you will have no doubt seen interest rates/cash rates/mortgage rates close to the 20% mark or otherwise you may have heard your parents talk about it – my parents often talk about their first loans at these kind of levels.  No economist is predicting we will ever get to those levels again, but they all seem to be in agreeance that to stay at almost zero was never going to last.

The graph below serves as a really good reminder on the history of interest rates.  

30 Year History. Source: RBA

As you can see from the graph, we haven’t seen a rate rise in over 10 years.   The government eased rates to all time lows (of almost zero) over the last two years which meant money has been incredibly ‘cheap’ (and still is!) and the impact of promoting consumer spending and keeping the economy thriving, during a pandemic and recovery, happened as desired.

What’s the goal with inflation?

Throw in some world crises [Russia/Ukraine war, China in lockdown and supply chain issues resulting in cost of commodities increasing, petrol prices soaring and so on] and the CPI index (i.e cost of living/inflation) has risen up rapidly to around 5%.    Our government aims to have an inflation measure of 2-3% so when it’s outside this range they take the action that they can to manipulate the economy back to what they consider a healthy state.  

One of the key levers they have available to pull is increasing interest rates. 

How high will interest rates go?

Until we start to see the inflation measure closer to the level desired, you can expect interest rates to be on the rise. 

Sifting through lots of research and economist views, the consensus seems to be predicting rates could rise a further 2% over the next 12 months up, potentially up to around 4% within the next couple of years.  Most views are saying they won’t go beyond that.   

What’s going to happen to Property Prices?

The screeching news headlines with how the market is predicted to dump needs to be put into context; the residential market in most capital cities has been rising between 3% and 6+% PER QUARTER for the last 18 months [source: ABS – https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/residential-property-price-indexes-eight-capital-cities/latest-release]. 

With money being so cheap you can make sense of why the prices have soared.  With interest rates on the rise, yes property prices will most likely soften and probably pull back a bit.   The flow on effects of people with high debt levels against their property will feel the pinch when interest rates rise but let’s hope they’ve been sensible and taken that into account when taking on that debt.

Money Mode Advice Pty Ltd (ABN 29 627 492 791) is a corporate authorised representative of First Financial Pty Ltd (AFSL 481098, ABN 15 167 177 817)

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This presentation provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

Renae Vercoe
administrator
Founder of Money Mode, financial professional, passionate educator, partner, mum and financial freedom fighter!