Australia’s top 4 banks fixed their 5-year fixed term interest rates, sparking the debate on how much lower rates might go on the short-term. Many home investors have been fixing at record low rates in anticipation of the Reserve Bank lifting rates in the future, with the Banks offering low terms in an effort to capture market share.
I can still recall my mother dealing with 18% interest rates, and the impact it had on our lifestyle. Higher interest rates result in less spending capital available by consumers. It slows the economy down, reduces Inflation, and ensures the cost of living does not increase to a point where people cannot afford to live.
The following chart shows the Australian Interest Rates from 2005 to present. Peaking at 7.25% before the Global Financial Crisis (GFC) hit, Interest Rates were not so high as to pull the handbrake on the economy. But enough to ensure consumers were not spending recklessly.
Lowest Rates ever!
A sharp decline as the severity of the GFC was realized, provided stimulus to an economy that was impacted by uncertainty from our two major trading partners: USA and China. Bottoming at 3.0% in 2009, current Interest Rates are at 2.5%, and have stagnated at this level since September 2013. This followed an 18-month decline.
For the data we have on file, since 1990, Australian Interest Rates have never been so low!
While the GFC may be all but over, economic stimulus is still rampant on a global level. Central banks from the US, Europe, Japan and even China are driving their respective economies in a hope that they will be capable of standing on their own two feet. At the same time, this is the only reason why the stock market is actually performing. Earnings results and fundamental data fails to support the valuations of current stock prices. There is a real disconnect between company growth and stock price performance.
Australia’s GDP growth rate for the same period has failed to provide confidence to investors. Currently sitting at 3.5% for the first quarter 2014, the economy has failed to reach the +5% highs from before the GFC.
Mining accounts for 13% of GDP, Manufacturing 11%, Construction 9%, and Agriculture 2%. The Services sector represents approximately 65%, dominating economic growth. Yet, economic success is based on agriculture and mineral resources. Hence, stock market focus is dominated by Banking and Mining.
With Interest Rates so low, the gamble for investors is that rates won’t go any lower then where they are now, at 2.5%. Of course this possibility of lower rates is feasible, it is a low probability. Inflation is currently at 3%, which is just within the target range of the Reserve Bank, and well below the peak of 5% from before the GFC.
This means the Reserve Bank has very little incentive to start raising rates any time soon. Slow growth in the economy does not create an incentive for action, and this means the debate on whether to fix or not fix will continue for a little while longer.
A recovery in the Housing market from early 2012 could be a pre-cursor to increased consumer spending, with the House Price Index rising from -2% to a recent peak of 4%. A drive in Consumer spending will lift Inflation, which would certainly lead to an increase in Interest Rates.
What to look for
The first hint of a rise in Interest Rates will cause investors to panic. They will lock in fixed term rates to ensure they “don’t miss out”. We need to see an improvement in GDP growth for this to occur. But the real ‘panic’ drive will come when the RBA announces an increase in rates. That first increase will spark the change in trend dynamics, creating the next big economic shift.