Should you be preparing for an interest rate rise?
No matter what financial news source you turn to at the moment, you’re likely to find commentary around rate rises – particularly the question: “When will they rise?” rather than “Will they rise?”.
So what conditions are occurring in the economy to fuel talk that the next move for rates is up, and what should mortgage holders be doing to prepare for such an eventuality?
Central banks overseas have indicated they are getting ready to raise rates so it will be no surprise that this will also be the Reserve Bank of Australia’s next move – not that the RBA needs to wholly take into account what other central banks do – its floating exchange rate allows it to make rate decisions that are relevant to Australia’s needs.
But the general consensus is that rates will rise, even more so considering that at a business lunch in September, RBA Governor Philip Lowe warned borrowers that they should “prepare for higher interest rates” and that it was more likely that interest rates will “go up than down”.
Looking ahead to a neutral cash rate
In July, the RBA announced it believed a neutral cash rate is 3.5 per cent. A neutral cash rate is where the rate has no impact on economic growth. The current rate of 1.5 per cent is deemed to be one that is expansionary, and once it has done its job of stimulating the economy through employment picking up and inflation rising, then it can be increased to 3.5 per cent to become neutral. At this level, the rate isn’t low enough to stimulate the economy, nor is it high enough to stifle any growth.
Traders have been pricing in a 25 per cent chance of at least one rate rise by February next year and markets are also predicting a second rate rise to have occurred by the end of 2018.
AMP chief economist Shane Oliver says strong business conditions and jobs growth along with the RBA’s own forecasts for a rise in growth and inflation point to an eventual rise in interest rates. “But slowing housing construction, risks around consumer spending including record low wages growth, low inflation and a too-high Australian dollar indicate that it’s too early to start raising rates now,” he says.
And there’s no guarantee that a rise will happen next year. For rates to rise, the economy needs to grow. At the moment, GDP growth is slightly above 2 per cent and a rate rise requires GDP to be around 3 per cent. Inflation also needs to move beyond its current 2 per cent rate to the RBA’s target of between 2 and 3 per cent.
The RBA kept the cash rate on hold at its October board meeting stating the “low level of rates is continuing to support the Australian economy”. However, the high dollar was again referenced in its accompanying statement.
The RBA Governor said the Aussie dollar had been continuing to appreciate and is expected to “contribute to the continued subdued price pressures in the economy”. He added the strong dollar is also weighing on the outlook for output and employment. “An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast,” he said.
What the RBA would like is for the currency to slide back towards US70¢ in order to lift Australia’s global competitiveness, boost national income and to inject some inflationary pressures.
The growing household debt is also regularly referred to as a concern, especially the fact that it is outpacing the slow growth in household incomes. However, action has been taken to address some of the associated risks of this situation. For example, APRA introduced a number of supervisory measures to tighten credit conditions and this may have been a contributing factor behind the recent fall in Sydney’s property prices – the first in nearly 18 months.
If rates rise then this will reflect an improving economy, something that many are hoping for, especially around wages growth.
Preparing for a rate rise
So what action should you be taking to prepare for a rate rise? While the timing for one remains uncertain, it’s always good to be ready. With interest rates at record lows, one of the most effective things you can do is set your mortgage repayments higher than the minimum. By doing so you are paying your home loan down more quickly. This also means you are financially ready for any rate increases down the track and it won’t be such a shock to your budget.
Another option is to fix your loan. This gives you peace of mind in knowing what you will be paying each month. If you want a little more flexibility you can always fix half your mortgage while keeping the other half at a variable rate. And of course it makes sense to try and pay off any expensive credit card debt as soon as you can.