What’s the impact of record low interest rates?

By Stephen Koukoulas, Economist

Interest rates in Australia are at record lows. It is not just the 0.75 per cent official rate set by the RBA which is at a rate never seen before, but interest rates for borrowers and savers have also never been lower.

The reasons for these low interest rates boil down to a simple fact – the economy is weak.

That sluggish pace of growth, which was at a decade low in the middle of 2019, means that inflation has been under the RBAs target for several years, the unemployment rate is now edging up and wages growth has been eroding consumer living standards.

The interest rate cuts delivered by the RBA are aimed to change this by improving the cash flow of householders and businesses with outstanding debt, but also to encourage new borrowers to step up their investment and spending levels.

It is too early to be sure just how effective the interest rate cuts in June, July and October have been, but there are tentative signs in consumer spending and house prices that they have delivered some stimulus. The lower Australian dollar has also given exporters a boost.

While inflation remains below the bottom of the 2 to 3 per cent target range, while unemployment is above 4.5 per cent and annual wages growth is weak, interest rates will remain low.

The market is pricing in one final 25 basis point interest rate cut in the first part of 2020, a move that would bring official rates down to 0.5 per cent. While further rate cuts below that are generally considered unlikely, financial markets are pricing official interest rates to remain around 0.5 to 0.75 per cent for the next three years.

Suffice to say, the outlook for borrowers is likely to remain favourable from some time to come, while for savers, the quest for yield is likely to be found outside traditional term deposits.

Only when the economy grows rapidly and wages growth and inflation see material increases will interest rates rise from the current record lows.

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