Why interest rates will stay near record lows for a decade

 

Home loan customers enjoying record low interest rates can afford to sit back, relax and enjoy the party.

The economic turmoil that's engulfed the planet during this coronavirus pandemic looks likely to keep rates low for a long, long time.

I'm betting it could last a decade or more.

That's because the Reserve Bank of Australia and other central banks around the world are hellbent on stimulating their struggling economies with ultra-low official interest rates.

It's also because the way they use interest rates is changing, and because borrowers have become so used to low rates that any slight rise will send consumers back into their shells and economies back into reverse.

There's a growing expectation that the RBA will announce another interest rate cut on Melbourne Cup Day, Tuesday November 3.

It won't be a big one, because the RBA's official cash rate - which drives variable mortgage interest rates - already sits at just 0.25 per cent. Economists have predicted it will go to 0.1 per cent.

 

Low interest rates have helped Australian housing avoid a COVID crash.
Low interest rates have helped Australian housing avoid a COVID crash.

The RBA's cash rate started its life as a tool to keep inflation between a 2-3 per cent target band, a level it says is just right for economic growth, but has recently evolved to combat high unemployment and support jobs growth.

The inflation-shifting impact of RBA interest rate cuts has also weakened, with annual CPI running below 2 per cent for most of the past six years despite multiple rate cuts. Inflation is currently at -0.3 per cent thanks to COVID.

RBA governor Philip Lowe has flagged continuing low (Lowe?) rates, and so have central bank boffins in the US and elsewhere.

Official interest rates are actually in negative territory in several European countries - where depositors pay banks to hold their money for them. Freaky.

A bigger worry among central banks is deflation, when asset values fall over time.

This should worry homeowners too, because it means the value of their house would drop and potentially push them into negative equity.

 

Reserve Bank of Australia Governor Philip Lowe is expected to unveil a small rate cut on November 3. Picture: AAP
Reserve Bank of Australia Governor Philip Lowe is expected to unveil a small rate cut on November 3. Picture: AAP

Multiply this effect across other assets such as investment properties, shares and businesses, and we have a very unpleasant situation.

Consumers won't buy anything if they reckon prices will be cheaper six months down the track, which can potentially destroy economies - COVID Mark Two.

The big question that seems unanswered in all the talk about interest rates is what will happen when rates start rising again.

Consumers tend to borrow the maximum they're allowed, which means even a slight increase in future costs causes pain.

For example, monthly repayments on a $400,000 mortgage at 3 per cent are about $1900. If rates rise to 5 per cent that interest bill jumps to $2350.

If they go back to 7 per cent - where they were just a decade ago - the monthly cost would be above $2800.

Where is a household struggling to juggle bills going to find a spare $900 each month?

Record-low interest rates are going to last longer than you think.

@keanemoney

Originally published as Why interest rates will stay near record lows for a decade



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