The Reserve Bank of Australia (RBA) has announced a rise in the interest rate from a record low of 0.1 per cent to 0.35 per cent on Tuesday.
Interest rates moving around is normal, but the last time they went up was in November 2010 so according to my maths-deficient brain this is a big deal.
So what does this all mean for my money, my rent and my ability to maybe one day (but probably never) buy a home?
What is the RBA?
The RBA is what’s known as a central bank, a key part of most countries’ economic systems.
In short, it can print money (yes, really), control interest rates, give out loans and does other economic tasks like managing stockpiles of foreign currency and gold.
In Australia it’s an independent body which is supposed to be free of government interference, and has a Governor and a board which makes all the hard decisions, like raising the interest rate.
Which brings us to:
What is THE interest rate?
So every loan has an interest rate, right? But this is THE interest rate. Economists and other wonks also call this the cash rate, and when it’s low they say that “money’s cheap”. So what does that really mean?
In short, the interest rate is the rate at which the central bank loans money to commercial banks to then loan to you, businesses or that kid from school whose parents’ paid for their house deposit.
In the simplest possible terms, when the rate is low it means repayments are cheaper than they would be if the rate was higher. Ergo, money’s cheap.
So when the RBA’s rate goes up, that means the rates at the commercial banks should also go up and vice versa. Now, this doesn’t always happen because our banks also borrow from other countries’ central banks, but if it goes up or down most people expect some movement in everyday people’s loan repayments.
Why have interest rates risen?
The reason the interest rates has been lifted today is because inflation is wayyy too high and the cost of living is downright unaffordable, which reflects pretty poorly on the government.
“The RBA supported what we were doing, and vice versa, our responses worked to support what the Reserve Bank was doing,” Prime Minister Scott Morrison said at a press conference following the RBA’s announcement.
AMP Capital chief economist Shane Oliver told PEDESTRIAN.TV the aim of raising interest rates was to lower the cost of living. It’s basically the only lever governments can pull to hopefully lower inflation by “cooling demand to some degree in the economy”.
The idea is: if interest rates rise people will chill out on spending and be less inclined to jump at the opportunity to buy a first, second, third or 17th home. Supply of goods and services will increase, demand goes down, therefore putting downwards pressure on prices.
What will happen to interest rates going forward?
This is a pretty low increase, from 0.1 per cent to 0.35 per cent, which is enough that the RBA appears to be doing something to address inflation but also not enough to rock the boat too much during the election.
But Oliver has predicted the rate could rise to 2 per cent by the end of next year.
“A 2 per cent rise in interest rates in times past might not seem to be a lot but we are coming from near zero and … that sort of interest rate hike will take [mortgage interest rates] to 4.5 per cent.”
Oliver however wasn’t worried rates would continue to shoot up and up and up.
“The Reserve Bank only wants to slow things down a bit to take pressure off inflation,” he said.
“They’ll feel their way along. They’re not going to go so far as to crash the economy or crash the property market.”
What does this mean for homeowners and first home buyers?
“There’s good news and there’s bad news here,” Oliver said.
Cost of living will now go up and for those already with a mortgage, which could further weaken household budgets.
For first home buyers it’s a little more complicated.
When interest rates double or triple and wage growth is only about 3 per cent, Oliver said it would likely make it harder for people to get a home loan.
BUT it will also (hopefully) drive housing prices down in the long term because there’ll be more supply and less demand.
Oliver expects house prices could drop as much as 15 per cent in both Melbourne and Sydney, so first home buyers might actually have more of a shot at saving for a deposit soon.
Finder’s senior money editor Sarah Megginson also warned the rate rise could make the government’s new Home Guarantee Scheme a potentially dangerous prospect for first home buyers.
“Asking people to get into a mortgage with only 5 per cent equity in a falling property market is a risky way of [helping people buy homes].”
What does this mean for renters?
Thankfully not much. The rental market is booming, vacancies are low in capital cities, so rent prices were already soaring. Oliver said the interest rate rise wouldn’t make a huge difference.
“I don’t think this necessarily means investors will suddenly jack up rents because rent’s already rising anyway. I think it just means a continuation of rent’s current pace,” he said.
“Investors aren’t as sensitive to higher interest rates as owner-occupiers because the way negative gearing works, say, if you’re on the top marginal tax rate and your interest rate doubles, you get almost half of that back from the tax man because the interest cost is tax-deductible.”
So basically: landlords tend to be richer so they can wait for tax time to recoup their losses.
Rents *shouldn’t* suddenly go up, but who knows what your evil landlord could decide to do.
