Interest Rates – Everything You Need to Know!

Welcome to our March blog. This month we’ll be discussing interest rates and what you need to know before investing in commercial property. While we will touch on where interest rates are headed, we will start with the very basics for those unfamiliar with how interest rates work and how they are impacted. 

What are Interest Rates?

Interest rates are a portion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding. Interest rates have a significant effect on home buyers, investors and the Australian economy as a whole and the official rate is set by the Reserve Bank of Australia (RBA). The Reserve Bank sets the target ‘cash rate’ (the market interest rate on overnight funds) and uses this as the monetary policy instrument, influencing the cash rate through its financial market activities. This is used by financial institutions to help determine what interest rates they will offer to their clients. These interest rates impact both deposits (i.e. the bank paying you interest on the amount of cash you keep in their bank) and loans (i.e. you paying the bank interest on the amount of money you owe them). 

How does the RBA’s position on interest rates impact you?

Many people view the RBA’s decision on interest rates to be a reliable barometer for how expensive (or cheap) bank loans will be to repay for Australians. When the RBA reduces or increases the official cash rate, the banks usually follow in turn, however, they do not always pass on the full increase or the full savings (in the case of a reduction) to their customers. 

Understandably, home loans are the most significant loans that most Australians will ever take out during their lifetime. It makes sense, therefore, that any change in the official cash rate is likely to have at least some flow-on effect, certainly for those with variable-rate mortgages. It is important to understand that banks don’t have to pass on interest rates changes to loan holders, though they often do this. They are a business, after all, with the intent to make a profit.  

When paying back a loan it is important to understand that interest rates can fluctuate substantially over the life of your loan. Making sure you are financially prepared to afford an increase to your repayments is critical, so we always recommend caution to ensure you can withstand the fluctuations (increases, specifically) as and when they occur. 

Interest Rates and the Federal Election!

In the run-up to the 1996 federal election, then opposition leader John Howard launched the Coalition’s housing affordability coverage, stating: “A Liberal and National government will operate a well-managed economy and deliver low-interest rates.” 

Australians had, in the recent past, seen interest charges rise to greater than 17 per cent (this happened throughout the late ‘80s), so the promise of decreasing interest rates proved to be a key part of a long-term recipe for electoral success for the Liberal Party.

Fast forward to the 2007 federal election campaign, and interest rates this time proved to be a detriment to the Coalition’s political fortunes rather than the boon that they had been earlier. 

About two weeks prior to the nation heading to the polls, the RBA raised the official cash rate during an election campaign for the first time ever. This was damaging to the Coalition, which was already trailing in opinion polls leading into election day. As we know, the Coalition lost that election, bringing the Labour Party back into power. 

Now, heading into the 2022 federal election, while the incumbent Coalition government has enjoyed a prolonged period of historically low interest rates, there is much speculation and expectation that the official cash rate may increase in the near future. There is also mounting pressure for interest rates to increase when you consider that inflation is starting to climb (to its highest levels in several years) and the rate of unemployment is also at incredibly low levels. 

When is the RBA going to give us a rate hike?

This is a popular query, but it’s not one that has a straightforward answer, unfortunately. While it’s inevitable that interest rates will have to rise, there is much speculation as to when this will occur, and also how quickly they will rise. 

In a statement following the first official meeting of the RBA for 2022 (on Tuesday, 1st February), RBA Governor Dr Philip Lowe said the RBA was “prepared to be patient” and will wait until actual inflation is sustainably within the two to three per cent range. 

While the recent trend has seen inflation around the above target range, we certainly have not seen this level of inflation over a sustained period, which would indicate the RBA are unlikely to rush into a rate hike in the immediate term. It stands to reason, however, that they will continue to monitor this inflation over the coming quarterly releases, as well as a broad range of other economic factors, and if the trend continues, we will likely see a rate rise. 

Some of the brightest economists in the country have forecast that the RBA will lift interest rates from as early as August 2022 which is well before the RBA’s stated 2024 timeline. 

The Commonwealth Bank of Australia’s chief economist, Stephen Halmarick acknowledged the need for the cash rate to rise sooner rather than later. He recently stated “Given surging inflation as well as strong employment and wages growth data, we maintain our view that the Reserve Bank of Australia will need to raise interest rates earlier than many expect, with an initial increase to 0.25 per cent in 

June this year, rising to a peak of 1.25 per cent in early 2023” 

We also note that the RBA stated its intention not to raise rates until the national growth of wages is “materially higher” than it is currently, so while there is speculation from various industry experts, such as noted above, that we can expect to see interest rates lifted by the RBA fairly soon, the RBA continues to take a cautious and measured approach, not rushing to increase rates until there is a more certain need to do so. 

When interest rates do start to climb, you may like to consider whether you are better to have a fixed interest rate for your loan rather than a variable rate. While you may pay a little higher rate in the short term by taking a fixed rate, it may save you a considerable sum over the longer term. You should consult with your financial experts, such as your broker, accountant and financial planner, if you are uncertain about the best options for your circumstances, making sure you consider all the pros and cons of the different loan options that are available.

Get in Touch for Commercial Property Market Advice

While we can’t offer you financial advice, we can offer great advice in matters related to the Commercial Property Market, so if you’re looking for some help, please contact one of our Agents today.