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October 19, 2010

RBA rules with an iron interest rate fist


It wasn’t just homeowners and property investors who were given a reprieve on October 5 when the Reserve Bank declared it intended to keep interest rates on hold; certain sectors of the economy also took the announcement as welcome news.

BY ED NIXON

While many economists were surprised by the Reserve Bank of Australia’s (RBA) decision to keep the cash target rate on hold due to various positive economic indicators – including escalating employment levels and a resources boom the likes of which Australia hasn’t experienced since the late 19th century – some are questioning whether our fiscal position is really as vigorous as the policy makers would like to believe.

With continuing uncertainty surrounding the economic status of other developed nations and the Aussie dollar going from strength to strength, the fact of the matter is we might be putting the horse before the cart with all this ongoing talk of an impending inflationary blowout.

Okay, so the commodities market is steam rolling ahead at breakneck speed, largely due to demand from China, but does that mean every state and every sector of the economy is performing at their peak?

It’s safe to say that Queensland and Western Australia will benefit directly from the current resources boom, but what about the rest of Australia? The problem is that if the RBA takes a generalised look at the Australian economy and believes it to be racing out of control, it will act to rein inflation in aggressively; and we all know what weapon it will pull from its arsenal to do so… interest rates.

While increasing the official cash rate might seem like the most effective monetary policy when it comes to putting a lid on our over-heating economy, is it simply too big a stick

?

What happens to those states that aren’t performing at optimum levels right now, like New South Wales? What about industries like retail, tourism and manufacturing; all of which will undoubtedly feel the impact of the Aussie dollar’s growing value, particularly in the lead up to Christmas?

Even the RBA’s Glenn Stevens acknowledges that some industries (such as tourism), are currently feeling the pinch as the dollar continues to rise and admits that interest rates are, “a blunt instrument when it comes to keeping the economy in check”.

Nice of him to note, but that doesn’t help the growing number of Australian families struggling to cope with mounting debt, or potential homebuyers who already can’t afford to secure their first home due to affordability issues.

It’s great that the resources boom is almost singlehandedly maintaining our economic momentum at present, but what about the average mortgage holder who will be paying an extra $320 more than they currently pay on a $373,000 variable loan if interest rates increase five times (or by 1.25 per cent) by the end of 2011, as some are suggesting will occur?

Such a scenario would surely impact the property market, with many homeowners and investors already being forced to take on mounting debt in an attempt to keep up with inflated house prices.

Data from the RBA indicates that the ratio of household debt to income peaked at a worrying 159 per cent in the June quarter this year, largely due to higher mortgage debt.

With so many people living beyond their means, the last thing Australian families need is a succession of rate rises from the RBA. Maybe it’s time the ‘big wigs’ in Canberra and the RBA start to think of some other way of keeping inflationary pressures under control. Maybe there is a more direct tool that can target specific areas of the economy that are largely responsible for rising inflation.

I’m not sure what that might be. But using such a broad brush stroke as interest rates seems a tad unfair on the average Australian family.

borrowers who appreciate the security a fixed term brings, or fear the uncertainty of what lies ahead for interest rates; this is an alternative well worth considering.

Ed Nixon has been in finance since 1991, with 12 years experience in commercial finance. Ed is a leading expert in mortgage broking, specialising in the structuring of multiple loans for continued borrowing. He is passionate about helping people grow wealth through property. Visit http://www.trilogyinvestmentpropertyfunding.com.au/

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2 Comments

  1. I agree whole heartedly. In my circumstances as a sole provider for my family with an already substantial mortgage payment to make, the only area that I will be able to cut back on to pay for an interest rate increase is on groceries. I have not bought any new clothing for months, gone to the movies or on holidays or anything else. Ordinary Australians like me are already suffering and with the SE Queensland property market stagnant at the moment I don’t even have the option of selling. I think the government and RBA definitely needs to come up with something much fairer, otherwise I think there will be a real risk of a property crash as many go to the wall because they can’t afford to pay their mortgages.

    Comment by Krystil — October 27, 2010 @ 1:16 pm

  2. “the Reserve Bank of Australia’s (RBA) decision to keep the cash target rate on hold due to various positive economic indicators – including escalating employment levels and a resources boom the likes of which Australia hasn’t experienced since the late 19th century” – what the? The decision to keep rates on hold instead of increasing them was in SPITE of escalating employment levels and the resources boom – they were the very reasons why they intended to increase the rate.

    It was surprisingly low inflation figures and dropping house prices that kept the finger from the trigger.

    I’m not sure if you really don’t understand economics or it was just badly written.

    Comment by Simon — October 31, 2010 @ 6:35 pm

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