In a significant move, the Reserve Bank of Australia (RBA) has raised the cash rate by 0.25 percentage points for the fourth time this year, aiming to tackle persistent inflation issues.
The ramifications of the RBA’s decision, while most acutely felt by mortgage holders, also have broader implications for various segments of the population, including renters and savers. Understanding these impacts requires a closer examination of the cash rate itself.
The cash rate, which the RBA determines, is Australia’s benchmark interest rate applied to unsecured overnight loans between financial institutions. Essentially, it reflects the cost for banks to borrow from one another. An increase in the cash rate typically leads to higher borrowing costs for banks, which in turn results in elevated interest rates for consumers seeking loans.
As of Tuesday, the cash rate has been adjusted to 4.6 percent in an effort to control inflation that has exceeded the target range for most of the past six years, according to Belinda Allen, head of Australian economics at the Commonwealth Bank. She notes that rising interest rates make loans more expensive while enhancing the appeal of savings. This dynamic tends to curtail household expenditures and business investments, gradually alleviating some of the inflationary pressures in the economy, with an eventual aim of returning inflation to the RBA’s target of 2-3 percent.
The immediate impact of the rate hike is most pronounced for Australians with variable-rate mortgages, as banks typically pass on the RBA’s increases in full. Shane Oliver, chief economist at AMP, emphasizes that the cash rate is the primary mechanism influencing borrowing costs, and borrowers should anticipate swift reactions from lenders. Historically, banks have announced corresponding mortgage interest rate hikes on the same day as RBA increases.
Allen highlights that families with mortgages may reduce their spending or dip into savings to maintain their expenditure levels due to higher interest rates. This adjustment in cash flow is a key way that monetary policy affects demand within the economy. Each 0.25 percent increase in the cash rate adds approximately $91 to the monthly repayments on a $600,000 variable-rate loan with 25 years left, amounting to an increase of about $360 per month as a result of the four rate hikes this year, equating to around $4,320 annually.
For those in the market for a new home, the increase also has implications. According to estimates from Canstar, an individual earning an average full-time wage of $108,650 could see their borrowing capacity diminish by over $47,000, while a couple both earning average wages might experience a reduction close to $95,000.
Individuals with fixed-rate mortgages will not be immediately affected by the rate increase, as their rates are secured for the duration of the fixed term. However, once that fixed period concludes and the loan transitions to a variable rate, borrowers will feel the full impact of any subsequent rate changes.
For renters, the effects of rising interest rates are less direct. Some landlords may choose to raise rents to counterbalance the impact of increased borrowing costs, though many regions have regulations limiting the frequency and extent of rent increases. The RBA has also indicated that increased borrowing costs may not necessarily lead landlords to raise rents, as the dynamics of the rental market are primarily driven by supply and demand.
RBA chief economist Sarah Hunter explained that while individual landlords might consider raising rents in response to higher interest expenses, they must also compete with the broader rental market. If rents are increasing, it typically signals that demand is outpacing supply.
Recent findings from Cotality’s quarterly rental review indicate that national rents increased by 1.6 percent in the June quarter, largely due to a significant shortage of available rental properties. The national vacancy rate remains at 1.6 percent, unchanged from March and below the five-year average of 1.8 percent.
On a positive note, rising interest rates can benefit savers, as interest rates for savings accounts and term deposits often increase following an RBA hike. This is because the cash rate influences the rates of return on deposits. Dr. Oliver anticipates that as the cash rate rises, savers may enjoy higher returns on their savings.
Additionally, higher interest rates generally bolster the Australian dollar, as they make investing in Australian interest-bearing assets more attractive to foreign investors. This increased demand for the Australian dollar tends to elevate its value, which can subsequently lead to lower costs for imported goods.
