Interest rates control the price of borrowed money when interest rates are low people are more likely to spend. This increases the demand for production, jobs and as a result, help stimulate more activity in the economy. They form a significant part of the government’s monetary policy and are determined by the Reserve Bank of Australia. The interest rate or cash rate targets are adjusted according to the economic situation of the country and take factors like GDP and unemployment into account.
Medium-term interest rates refer to the interest rates on bonds with maturity dates between two and ten years, while long term interest rates are related to bonds that mature in more than ten years. Both the medium-term and long-term bonds are subject to interest rate risks as the rise in interest rates leads to a fall in bond prices and vice versa. However, long-term bonds are more sensitive to interest rate changes due to their greater duration.
Amidst the challenging economic conditions owing to COVID-19, the cash rate in Australia is at a record low of 0.25%. The Reserve Bank of Australia dropped the cash rate from 0.75% to 0.50% on March 3, 2020, followed by a further drop to 0.25% on March 19, 2020. The cash rate remained unchanged at 0.25% after the April and May meetings of the RBA.
The decision to reduce the interest rate and to keep it at the record low was made with the difficult financial scenario in mind. The coronavirus outbreak had a significant impact on the Australian economy and continues to delay progress towards reaching full employment and inflation target of 2-3%.
The projected output of the country is expected to drop by 10% for the first half of 2020 and around 6% for the full year 2020. Additionally, the unemployment rate is projected to reach its peak at about 10% in the next few months and remain above 7% by the end of the year. In such taxing times, the decision to cut interest rates is meant to keep the credit available, funding costs low, and support employment and economic activities.
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Home loan rates are the ideal measures to assess whether the banks have transferred the full benefit of interest rate cuts to the customers. Lower mortgage rates make homeownership more affordable and as a result, can help stimulate the property market.
It is also important to consider that mortgage rates can be fixed or adjustable. The interest rate for fixed-rate mortgages is fixed when the loan is taken and does not change, while the interest rate may go up or down for an adjustable-rate mortgage.
At present, the average home loan rate for 30-year fixed-rate mortgages is around 3.8%, compared to an average rate of 4.25% in 2019. It is noteworthy that the average home loan rate is on a downward trajectory. The current average mortgage rate is lower than the past 10-year average of 4.03% and much lower than the average home loan rate over 50 years. The average home loan rates in Australia exceeded 10% for the first time in 1974, reaching a record high of 17% in January 1990. In four years from the record high, the average mortgage rate reached 8.75% in 1994 and averaged around 10% since then.
Thus, the current home loan rates are statistically much lower compared to the historical averages for the past 10 or 50 years. It indicates the criticality of the situation and the dire need for the government to take measures to support the challenged economy and prevent a looming recession.
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The changes in monetary policies, including interest rates, are usually timed around major economic changes. The interest rates tend to decline during and after economic shocks and grow along with the growth of the economy.
The government needs to reduce borrowing costs and stimulate the economy during the challenging times, by reducing the interest rates. For instance, during the great financial crisis of 2008, the RBA cut down the cash rate by 100 basis points to 6.0%, and Australia could afford to be one of very few countries to avoid the great recession.
The GDP growth of most countries, including Australia, has suffered a significant blow since the Coronavirus pandemic and has led to a very fragile economy. The RBA has to resort to similar strategies of dropping the interest rates down to encourage borrowing and spending and stimulate economic activities.
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With the interest rates already at their record low of 0.25%, the interest rates are expected to remain at the same point due to the significant effect of the coronavirus outbreak. The Board of the RBA indicated that they do not intend to increase the cash rate until the country starts progressing towards its target of full employment.
The future does not look very optimistic, as well. The country, along with the world, is expecting a large economic contraction, and the unemployment rates are expected to reach their highest levels of the past many years. Therefore, the outlook is to keep the interest rates as low as possible to allow the economy to survive the blow and reemerge.
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