The Reserve Bank of Australia (RBA) and the major trading banks may play the most visible role in setting interest rates. But in many cases they are being reactive rather than proactive.
A wide range of external factors feed into their decision-making process. This includes our collective behaviour as investors and savers, borrowers and consumers. Then there’s the rate of inflation and wages growth, foreign currency exchange, the economic health of our trading partners, and the interest rates paid by local banks to borrow money from overseas.
Suddenly it’s not so easy to figure out where interest rates are headed, even in the short term.
A fine balance
To look at just one part of the puzzle: the RBA dropped the cash rate to 0.10% in November 2020 – the lowest rate on record. This made it cheaper for businesses to borrow and invest in job-creating activities.
However, mortgage rates also followed the cash rate down. This allows homebuyers and investors to borrow more which subsequently drove up house prices.
So how does the RBA keep a lid on housing costs without choking business activity and consumer spending?
One way is to get by with a little help from its friends, in this case, the banking regulator, the Australian Prudential Regulation Authority (APRA). Order lenders to keep a tight rein on ‘risky’ loans. For example, where loans exceed 80% of the value of the property.
In May of 2022, the RBA increased the cash rate by 25 basis points to 0.35%. Marking the first rate rise since November 2010.The RBA decided to cut interest rates to assist in curbing the rapidly rising inflation rate across the country. With the economy recovering more quickly post-pandemic than initially expected.
Benchmarking
The Bank Bill Swap Rate (BBSW) affects the interest rates in Australia. The ASX calculates the cash rate at the same time every day and bases it on the rates being bid and offered by approved trading institutions on short-term interest-bearing securities. General interest rates are set by financial institutions in reference to the BBSW.
Navigating uncertain waters
Appreciating the complexity of interest rates doesn’t always help in deciding how to respond to them. Even the experts often get it wrong when trying to predict where interest rates are going. This doesn’t help answer borrowers’ eternal question: “do I lock in a fixed rate, or opt for a variable rate?”
Locking in current rates provides protection against future mortgage rate rises. In the current rate environment, it’s very tempting to fix the rates on at least part of a mortgage, and for as long as possible (usually up to five years).
Based on recent activity, in the event that rates continue to rise, variable rate borrowers pay more. However, with rates already so low, rises are likely to be gradual, which can minimise the downside risk.
Still not sure what to do? If your mortgage is due for a review or you’re looking to invest or buy, talk to your licensed financial planner or mortgage broker to get a professional opinion.
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