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By Mark Bouris
Everyone seems to have an opinion on interest rates at the moment.
Some say they need to go up further.
Others say they must come down.
Lots of these declarations are based on myths.
So let’s bust some of them.
Many have made the point that the United States has just delivered an interest rate cut. Therefore, they argue that Australia should cut too.
The reality is that the United States began hiking interest rates before Australia. So it’s not surprising to see Australia lag behind the US on interest rate cuts.
The same goes for New Zealand.
New Zealand cut interest rates in August. But New Zealand began hiking its cash rate in October 2021. That’s six months before Australia handed down its first interest rate hike. We’re playing catch up – and we will remain playing catch up for several more months.
Another myth is that Australia’s current interest rate regime is much harsher than the United States.
To debunk this, we have to introduce the concept of a real interest rate.
A real interest rate is one that has been adjusted for inflation.
It reflects the real cost of funds to the borrower and the real yield to the lender.
In the United States, their real interest rate is 1.8 per cent, because their cash rate is 5 per cent and their core inflation is at about 3.2 per cent.
In Australia, our real interest rate is about 0.5 per cent, because our cash rate is 4.35 per cent and our core inflation is at about 3.9 per cent.
That means when adjusted for inflation, Australia’s interest rates are lower than the United States.
It also means that Australia’s real interest rate will be lower than the United States’, even if the Federal Reserve cuts another three or four times.
That’s not to mention the fact that GDP growth in the USA is higher than in Australia. So the Reserve Bank of Australia (RBA) isn’t being too harsh on borrowers when taking into account how other central banks around the world are behaving.
The other myth is that inflation has come down in Australia recently.
It’s true that the latest inflation data shows there has been a moderation.
But that’s because of the introduction of energy rebates by the Albanese government.
Electricity prices saw a sharp 6.4 per cent drop in July.
Without these rebates, the Australian Bureau of Statistics (ABS) estimates that electricity would have risen by 0.9 per cent.
If that happened, it’s likely that inflation would not have come down.
Another myth worth debunking is that when the Reserve Bank starts lowering rates, they will keep going down.
It’s untrue – and the history books prove it.
Between 1976 and 1982, the cash rate went up from 6 per cent to 20 per cent in Australia.
At the time, nobody expected that.
Then it was cut to 5 per cent by 1983.
But two years later, it was back up to 20 per cent.
This could happen again.
We could see interest rates come down and then go right back up. Borrowers must keep this in mind, especially as we enter a period of increased instability given what’s unfolding in the Middle East.
There’s something else to consider.
An interest rate cut could actually drive house prices even higher.
“Historically, periods of low and/or falling interest rates have coincided with borrowers taking on higher levels of debt and, in some cases, lenders extending credit to riskier borrowers,” the RBA said in its half-yearly assessment of the health of the financial system.
“Over the past two decades, the international experience has shown that assets that are heavily reliant on debt funding, such as property, can also see unsustainable price rises, increasing the risk of a substantial market correction that could deplete households’ equity buffers and result in broader economic disruption.”
The RBA couldn’t be clearer.
Reducing interest rates at this point could actually drive house prices higher and push people into more debt.
We must be careful what we wish for at this fairly early point in the fight against inflation.
Article Originally published on news.com.au
