On August 2, 2022, the Reserve Bank of Australia made an announcement that they would increase the cash rate by 50 basis points. That increase would make the cash rate 1.85%, with forecasts indicating that it could get to 2.5% by the end of the year. That is the first time in 11 years that the Reserve Bank has raised the rate. It also announced an increase in the interest rate on exchange settlement by 50 basis points to 1.75%. This is after a 50 basis point rise in July.
Causes of Interest Rate Rises in Australia
The Governor of the Reserve Bank of Australia attributed the rise in the Australian interest rate to the high global inflation as well as factors such as disruptions due to COVID-19 and the war in Ukraine, which have put pressure on the productive capacity. The Reserve Bank of Australia further indicated that other than the global factors, some domestic factors such as increased demand and a tight labour market also played a role in the increase in inflation in Australia, leading to the Australian interest rate rise.
Comparatively, while inflation in Australia is high, it is not as high as in many countries. Forecasts indicate that it would peak towards the end of the year, possibly reaching a high of 7%, before dropping back to the 2-3% range in the coming year.
What the Interest Rate Increase Means to Businesses and Households
Households in Australia have been enduring price pressures for some time. The new rate rise is likely to compound that, given the impact, it would have on commodity prices. The surge in commodity prices would have an adverse effect on households. Households would be able to purchase fewer commodities with each dollar. Considering that wages are unlikely to rise at the same rate as prices, the spending power of households would decrease, leading to a drop in living standards.
For businesses, the interest rate increase may have different effects on how they operate. For some, such as health insurance companies, they may be able to shift the burden of high-interest rates to consumers by increasing prices for their services or goods. That means that households may have to contend with the pain of higher prices across different industries.
Some businesses may not have the flexibility of shifting the burden to consumers. Such businesses would have to contend with decreased profit margins before they can gradually adjust their prices to reflect the interest rate levels.
Overall, the final consumer would be the casualty of the rate rise. Most businesses would just shift the effect to the consumer, yet salaries and wages would hardly increase.
Overall Effect of Increasing Interest Rates on Commodity Prices
Forces of demand and supply often regulate commodity prices in the market. As demand increases relative to supply, the prices are bound to rise. However, when demand falls, prices also fall. When interest rates are high, borrowing becomes expensive, limiting access to financing. That leads to a decrease in demand. A drop in demand for commodities would force prices downward, bringing the prices to a level consumers can afford. That way, a rate rise helps in regulating commodity prices in the economy.
How the Interest Rate Increase Affects Your Loan
Interest rates are part of government policy to regulate economic growth. A big part of economic activity involves borrowing to finance investments, acquisition of homes, or even finance expenditure on consumer goods and services. Changes in the rates at which people borrow influence their expenditure. An increase in the rates would make loans expensive. The spiral effect would be lower demand for goods and services. That is because when borrowing becomes expensive, people borrow less. They also spend less due to decreased access to affordable financing.
For mortgages, an increase in the rate of interest is likely to result in higher repayment amounts. A mortgage with a variable rate would always reflect any changes in interest almost immediately. The homeowner would pay more as the rate increases. However, for a fixed-rate loan, an increase in the rates is not likely to affect the repayment amount until the fixed-rate period is over.
Choosing between a Fixed-Rate and Variable-Rate Loan
Fixed-rate loans and variable-rate loans both have benefits and downsides. Different economic circumstances make each option viable at the prevailing times. For instance, when interest rates are increasing, a fixed-rate loan would be more viable to protect you from high-interest expenses. However, when there is a fall in the rates, variable-rate loans become more attractive. For a borrower, it is very important to establish a good mix that will ensure the fluctuations do not have a negative impact on your finances.
Fixed loans offer stability in terms of interest payments within the fixed term. That means a borrower would continue paying interest at a lower-than-market rate when rates are increasing. On the downside, taking such a loan may lock one at high rates while the market rate drops. It would be hard to take advantage of the falling rates.
Variable-rate loans may be cheaper than fixed loans. However, they are more volatile, meaning that the rates would increase to match prevailing interest rates. That would result in the borrower making more repayments. However, when the rates drop, the borrower benefits as they pay less in repayments.
Borrowers may also have the option of split loans. Such loans allow the borrower to have part of the loan as a fixed loan with a fixed rate of interest while the rest remains variable. Such loans provide the borrower with the flexibility of variable loans and the stability of fixed loans. That shields them from the effects of fluctuations in interest rates. They can take advantage of a drop in rates while also enjoying the protection from rising rates.
When deciding on the type of loan to take, it is wise to research and consult experts. That would enable you to gather the necessary information to guide your choice of the loan that suits your needs. Some factors that you may consider include the purpose of the loan and the length of the loan period.
Easing the Pressure of Loan Repayments with High-Interest Rates
As the Australian interest rate continues to rise, many borrowers are likely to feel the heat of the new higher rates. Many would-be looking for solutions to ease the pressure of their loans during difficult times.
If as a borrower you are feeling the pressure of making repayments on your loan, you may need to talk to your lender and discuss possible solutions. A temporary change to your loan may be enough to make it manageable for you. You may opt to swap the loan repayments for interest-only repayments, reducing the burden of repayments. You may also opt to restructure the loan for easier terms that you can manage.
While changing the loan terms may ease the pressure, it may increase the loan term or the amount of interest you pay in the long term. It is therefore important to consider the overall effect of any such change.
