Movement in the Australian Interest Rate Could Happen Soon

Photo: The Conversation

There is widespread speculation that a movement in the Australian interest rate will happen soon.  But which direction will it go? 

Opinions vary – those worried about unemployment favour a rate cut while others focused on curtailing inflation back an interest rate rise. 

While the worsening labour market is certainly worrying, the risk of inflation growing beyond the RBA’s target band of 2-3 per cent does lend strong support to an increase in the interest rate. 

What Factors Drive Interest Rates to Rise?

The main argument for an interest rate increase is to reduce inflationary pressures. 

Inflation refers to changes in consumer prices and it has received a lot of attention recently as ABS data showed a 0.8 per cent upswing in consumer prices for the December quarter, lifting the annual inflation rate to 2.7 per cent. 

“With a hike in rates presenting so many challenges, one must question whether our economy is ready for all of this.”

Increase in house prices, excessive consumer spending and the fall of the Australian dollar have been blamed for the growth in prices. Of course, the underlying low interest rate environment last year was the real catalyst to encourage spending, borrowing and investing while helping to keep our dollar low to the detriment of our import sector.

Tradable goods such as clothing and electronics have prices determined on world markets and make up of around 40 per cent of what we buy, and a weaker dollar means costs are growing for these items.

What Impact will an Interest Rate Increase have on the Economy Generally?

Higher interest rate makes borrowing, spending and investing less attractive though it encourages savings.

Cash flows will be tighter as interest payments on household debt rise, so consumer spending will reduce and slow down some sectors of our economy.

Higher borrowing costs will also deter business investments, potentially making private sector job creation more difficult.

“A national interest rate increase… will likely cause housing market activities and construction to decline across Australia…”

The Aussie dollar could go up depending on the health of other global economies such as China, US, UK and Europe.

Our export sector will become less competitive with a stronger dollar but importers will benefit.

With a hike in rates presenting so many challenges, one must question whether our economy is ready for all of this.

How Will an Interest Rate Rise Affect the Housing Market?

According to the RP Data – Rismark Home Value Index, after national home values fell in 2011 and 2012, 2013 saw a return to growth of 9.8 per cent, driven by Sydney (+14.5 per cent), Perth (+9.9 per cent) and Melbourne (+8.5 oer cent).

Other cities such as Brisbane, Canberra, Adelaide, Darwin and Hobart grew at a much slower pace.

A national interest rate increase however, will likely cause housing market activities and construction to decline across Australia, leading to further job creation issues. House prices may fall nationally due to reduced demand as potential buyers are put off by higher borrowing costs.

With such an uneven housing market recovery, a second question must be asked as to whether the housing markets across our capital cities, with the exception of Sydney, can withstand the impact of an interest rate hike.