Interest rate hikes: what they mean for you
The wait for savers and investors is over. After keeping interest rates at record lows for a number of years, this month the Reserve Bank of Australia (RBA) delivered its first increase in the Cash Rate since November 2010.
With fuel prices increasing due to the war in the Ukraine, the price of everyday items rising as a result of the global pandemic and the Australian economy reaching full employment, the RBA has begun increasing rates in a bid to stem inflation.
According to the RBA, the increase of 0.25% is expected to be the first in a series of hikes designed to keep the rate of inflation sustainably within the 2-3% range.
So what does this change mean and how will it affect you and your organisation?
Higher interest rates make borrowing more expensive. That could mean higher costs on property borrowing, credit cards and loans.
However, the interest rate rise will not affect all Australians equally. Only around a third (35%) of Australians currently have a mortgage, with the other third (32%) renting and 32% owning their home outright1.
In addition, during the COVID-19 pandemic many households, businesses and other organisations took the opportunity to reduce debt and increase savings. In January this year Treasurer Josh Frydenberg, citing APRA data, said Australian households had put away $245 billion during the pandemic, with businesses accumulating an additional $179 billion2.
As a result of this prudence coupled with a stronger economy, in our view unless interest rates rise significantly in Australia, the number of borrowers experiencing stress or defaulting on their loans is likely to remain low.
Savers and investors
For savers and investors, an increase in the cash rate is likely to spell good news. In recent years the ultra-low rate environment has meant many savers and investors have had to take on more risk in order to receive returns that are in line with their long-term goals.
In addition, the increase in consumer prices has been impacting the real rate of return on savings.
Let’s say you have $1000 in a savings account that pays a 1% interest rate. After a year, you will have $1010. However, if the rate of inflation is running at 2%, you would need $1020 in your account to have the same buying power that you started with.
Effectively, inflation means your money’s purchasing power can decline while you are saving it. This is one of the reasons why an increase in interest rates is often welcomed by savers.
Rate rises may also benefit investors, as they often mean the economy is growing, unemployment is falling and corporates are well capitalised. All of these indicators generally spell a positive outlook for investments over the medium to long term.
The RBA’s recent rate move signals that Australia’s ‘lower for longer’ interest rate environment may be drawing to a close. While rate hikes may negatively impact a minority of borrowers who have over-extended themselves, for the majority of Australians the move is likely to reap rewards.
1. ABS: 2016 Census of Population and Housing
2. AFR: Savings war chest grows to $424 billion
By Edwin Lo, Senior Portfolio Manager, UFS
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