What’s happening and what you can do.
We know that in the current market interest rates are low and whilst the upwards direction is quite clear, the timing and pace of rate increases remain fuzzy. Financial markets provide some hints and recently Philip Lowe, Governor of the Reserve Bank of Australia (RBA) has given insight to what’s coming.
Question is; are you prepared?
Your next step will determine your financial health in a rising interest rate environment.
Will you consult widely and develop a plan of action?
Will you need funding to reposition yourself and your business?
This is the first of a series of articles discussing interest rates, how you can respond and how we can help you put a plan in place. This series will focus on education, financial awareness, and commercial aspects.
To help you navigate the changing market conditions, we’ve put together a series of articles about interest rates. How you use this information will determine if you thrive or barely survive. We are intent on helping people devise a plan to ride these conditions and come out on top.
We all like low interest rates, right?
It depends, borrowers prefer lower interest rates but investors prefer higher interest rates. Retirees bemoan the low return they’re receiving on cash investments but don’t feel too bad for them, most have enjoyed a buoyant property market over the last 30 years, aside from a couple of dips.
Borrowers revel in rising property prices coupled with low interest rates because it enables the funding of additional property investments, property improvement, and a lavish lifestyle. Banks were complicit, property values were supportive and loan servicing standard were easily met given lower repayments. Happy days. Everyone was encouraged to join the party propelling the property market ever higher and leading to high debt levels with low debt carrying costs.
Popular trends emerged with many borrowers converting to or requesting interest-only loans where no principal loan repayment is made, others leveraged homes to fund share portfolios, creating a potent double whammy when property and share markets devalue together. In recent times, interest-only loans became quite necessary as wages failed to increase at a rate necessary to keep pace with property values.
A global study has warned that there are negative implications associated with low interest rates over a long period. According to the Bank for International Settlements (BIS), the practice may even dampen the profitability and strength of financial firms.
Now stop the music: not everyone realises that the party is well and truly over. Going forward, high debt levels come with higher debt carrying costs and gaining additional funding is constrained by falling property prices and higher loan servicing standards. Controls placed on Banks make interest-only loans very difficult to obtain and income verification standards are higher.
What do the financial markets indicate?
The Reserve Bank has held the Cash Rate steady at 1.5% since August 2016. This setting aims to support economic growth by being a source of stability and confidence in the economy; however, the Cash Rate is one of many factors determining the cost of wholesale funding. The wholesale cost is a Bank cost for sourcing funds to on-lend to retail business and consumer clients. Why the RBA does what it does and how Banks arrive at their loan interest rates is a topic we’ll cover, suffice to say that an important change has occurred in the cost-of-funds.
Our charting of the three month Inter-Bank Swap Rate (BBSW) indicates that the traded price of cash reduced steadily since 2012 from 3.15% to a low of 1.87% in December 2017. Everyone will have enjoyed playing that oh-so-fun game of bragging about who has the lowest variable interest rate. It’s been fun but since December, the cost of cash increased for the first time in a decade and has quickly stepped up to 2.16% in July 2018. The cost of cash will continue to rise from here through to the next financial shock.
The cash price direction change from falling rates to increasing rates means a couple of significant things;
- Standard variable rates have bottomed and will not reduce any further (unless under a marketing campaign designed to win market share);
- Fixed interest rates have bottomed a while ago and are also moving upward.
You should take these into consideration when deciding whether to take a variable rate or fixed rate. The above is true at the time of writing, for further clarity, chat with us today.
What does the RBA Governor say?
The Reserve Bank of Australia Governor, Philip Lowe made four important points during a recent speech at the launch of ASIC’s National Financial Capability Strategy 2018. The Governor suggests;
- Interest rates move up and down, “Many borrowers have never experienced a rise in official interest rates. They have mostly experienced lower rates. At some point this will change.” Further, “This will not be welcomed by some, but it would be a sign that things are returning to normal. My advice here is to make sure your finances can withstand a lift in interest rates.”
- House prices move up and down, commenting that, “We are seeing an example of this in Sydney and Melbourne at the moment. And most of our cities have seen falls in housing prices at some point over the past decade. While I would expect housing prices to trend higher over time as our incomes increase, there is no guarantee that your home will be worth more tomorrow than it is today. So plan accordingly.”
- Make sure you build adequate financial buffers, commenting that “Things don’t always turn out as we expect. So for most of us, having a buffer against the unexpected makes a lot of sense.” His comment recommends building a cash savings buffer.
- Shop around, commenting “Don’t be shy to ask for a better deal; whether for your mortgage, your electricity contract or your phone plan.” There are good deals out there, seek advice, get good information and make informed decisions.
Interest rates have been supportive for a long time, enabling borrowers to leverage their assets and carry a high debt load with a low servicing cost. Market data suggests an inflection point where interest rates have bottomed and will rise in future. The pace and timing of both RBA Cash Rate and wholesale cost-of-funds increases remains unclear; navigating a funding solution or refinance in this environment is possible, and to do well you’ll need expert advice.
Understanding the financial climate, where you’re at and what’s possible will keep you ahead of the game. Reach out to Influx Funding for a free assessment of your position and to explore possibilities.
1. Marion Kohler and Michelle van der Merwe, Sept 2015, Reserve Bank of Australia, Long-run Trends in Housing Price Growth, https://www.rba.gov.au/publications/bulletin/2015/sep/3.html
2. Australia Three Month Interbank Rate,1986-2018, Data, https://tradingeconomics.com/australia/interbank-rate
3. Philip Lowe, 17 August 2018, Reserve Bank of Australia, Opening Statement to the House of Representatives Standing Committee on Economics. https://www.rba.gov.au/speeches/2018/sp-gov-2018-08-17.html
4. Philip Lowe, 21 August 2018, Reserve Bank of Australia, Remarks at the Breakfast event to launch ASIC’s National Financial Capability Strategy 2018, https://www.rba.gov.au/speeches/2018/sp-gov-2018-08-21.html