Why interest rates WON’T hit 18%

//Why interest rates WON’T hit 18%

There is a very good chance interest rates will be lifted next week when the Reserve Bank meets. Regardless, I’d put money on at least one interest rate before the end of the year and three or four in 2011 and that doesn’t include what the banks might do.

Now that doesn’t sound too exciting especially if, like me and 90% of Australian’s with a mortgage, you have a variable interest loan; but it’s not all bad news. Interest rates are adjusted by the Reserve Bank of Australia (RBA) to control inflation and high inflation means the economy is strong. In turn a strong economy with low unemployment means we see wages and skilled migration increase, both of which are very good news for property price growth.

For some this is little concession when with each rate hike they are paying more to hold their property and the unknown of when the rate rises might stop. This fear is played on by elements of the media and even some family around the BBQ who are keen to remind us of the horrors of the high interest rates of the late 1980’s. The truth is that the policy mandate, or role of the RBA, as set out by the Commonwealth Government, has changed over time ensuring that this won’t happen again.

After the extreme inflationary conditions in the late 1980’s the RBA informally set out to control inflation by changing interest rates to keep CPI within a 2-3% band (generous by developed nation standards and indicative of our economic strength). This policy of ‘inflation targeting’ was formally agreed to and accepted as a mandate by the RBA in 1996. Since then, the RBA has been able to keep inflation in check and assist with the stimulus of the economy through the GFC by adjusting interest rates accordingly. The recent six rate hikes (the most aggressive in 16 years) only brought the interest rate back to a ‘normal’ setting, but was enough to stem the rapid rise in national housing prices brought on by low rates and the First Home Buyers Boost. So while the fundamentals of the property market are strong, it has helped avoid an over-correction of property prices exceeding wage price growth.

The average variable interest rate post deregulation of the Australian dollar in 1983 and prior to inflation targeting was 12.3%. The effect of inflation targeting has meant since the change it has only averaged 7.3%. Of note, minutes of the RBA’s meetings have only been made public since December 2007 so the detailed discussion and understanding around interest rates, the RBA’s role and how they decide to change them or not, is only a new phenomenon. It’s no wonder most people still don’t understand the extent of the change and the steadying influence it has on our nations interest rates.

So while it’s important to understand the impacts on our budgets and cash flow by interest rate changes, we have no need to fear the sensationalist’s stories about a return to the 1980’s and can instead think about the many benefits that come with living in the lucky country – like the opportunity to own and invest in property.