What's happening with interest rates, and what you should do with your debts August 20th, 2022

It’s the big debate raging in the world of economics at the moment.

How high will interest rates rise and when will they come back down to more affordable levels?

For borrowers, perhaps you or maybe your kids or grandkids, they’re particularly interested.
And in seeking an answer, never forget the goto joke about economists.

Three economists decide to go target shooting. The first misses the target by a metre to the left, the second by a metre to the right and the third economist shouts out, “we got it “!

The debate about further rates rises over the next few months is over.

Sadly (for borrowers), our rampaging inflation rate guarantees a number of rate rises up to Christmas and beyond. Instead, the focus is now beginning to shift from how “high will they go”, to “are these higher rates here to stay”?

More and more economists are beginning to think it’s the latter.

To understand the dilemma, it’s worth revisiting some of the economic basics.

Central banks like the Reserve Bank of Australia or RBA amongst other things, are charged with keeping our economy stable, predictable and growing. That means an economy with an inflation rate somewhere between 2 and 3 percent, low unemployment, a stable Aussie dollar and reasonable rate of economic growth.

Perhaps it is an indication of the level of concern, but the Consumer Price Index (CPI) data was being released quarterly by the Australian Bureau of Statistics. As of October 2022, we’ll be receiving monthly updates. Right now at 6.1 percent, our inflation rate is nearly double the target range. Our unemployment rate is close to historical lows and economic growth has slowed.

Indeed on the 18th of August, it dropped again. The art, is to keep all of these variables in balance. Kind of like Goldy-locks and the three bears stuff: “Just right”...

Isn't zero unemployment a good thing?

The issue is that zero-unemployment drives wage-increases (due to the scarcity of workers) which in turn leads to increased inflation. The RBA has a few tools to use, but it’s main weapon is to change the cost of money.

In other words, increase or decrease interest rates. It’s regarded as a sledge-hammer response, but there’s little else the RBA and Central Banks can do.

And sadly as seniors have discovered, the RBA’s not too focussed on savers. It’s all about people borrowing money to invest and consume.

If you go out to buy a new car on finance and all of a sudden the repayments are now $400 a month more, you’ll be less inclined to buy the new car.

And those with a mortgage will be less likely to get the pool installed for Christmas.
Conversely, if central banks like the RBA want to encourage people to borrow, they’ll lower the cost of the money by reducing rates.

So, if the RBA wants to slow things down?

They increase the cost of money so people think twice about spending. With that in mind, cast your mind back 14 years to the Global Financial Crisis or GFC. Some Netplan subscribers were still in year 1 at primary school.

At the time, it looked like the world was staring at imminent collapse of the world financial system and unilaterally, Central Banks dropped rates to keep stimulating the world economy.
Many economists believe that once the GFC had passed, rates should have been returned to “normal” levels.

That would have seen the RBA with an overnight cash-rate getting back closer to it’s current 30 year average of about 3.85 percent - or 2 percent higher than where it currently sits.
The cost of those low interest rates has been an extraordinary period of growth in asset prices internationally, including shares and property. Just ask a potential first home-buyer for a practical example of what that means.

What are the economists saying?

Some economists expect that Australia and other economies are headed for a recession. As bizarre as it might seem, that would be good news for home-buyers. To stimulate growth, the RBA might be forced to pause any future rate rises or better still, lower rates again.

The problem here is that by then, the other effect of a recession might be starting to bite. Unemployment could be heading up and no matter what your financial position is, it is very difficult to repay a debt when you don’t have a job.

Some economists believe that with Australians having a relatively healthy level of savings, they’ll be in a good position to weather the storm.

In other words, the RBA might decide to reset the overall interest rate scene and push-on through to the "other side".

Much will depend on what the rest of the world decides to do.

What should you think about doing?

The advice for people with a home mortgage or any other form of non tax-deductible debt doesn’t change, no matter where rates are. Pay off your non tax-deductable debts as fast as you can.

Simple and brutal. Interest paid to your bank manager is dead-money, always get rid of it as quickly as you can.