INTEREST RATE OUTLOOK

Several readers asked us last week how high interest rates could rise.  Well, who knows?   And, as I replied to several folk, ‘how high’ is determined by your lived experience.  

If you’re old, like me, then you grew up with annual interest rates in the low to mid-teens.  If you’re young, interest rates above five percent are difficult to imagine.

The good news is that the long term evidence suggests that really high interest rates are more of an anomaly than the norm.

Historic research by Pimco suggests that annual interest rates mostly range between three and six percent.   See the chart below.

The chart also shows that interest rates are cyclical.   They never stay steady for long.  They go up and down.  And if they are going to start going up next, then a return to double digit interest rates – assuming the normal state of play – seems very unlikely.

So, I don’t have an answer to the ‘how high’ question, except to say that smarter people than me advise that you should have a 50% buffer: that is, if you are paying 5% per annum on your loan, you should be to be able to service, say, 7.5% to 8% in loan repayments.

Wise advice – but harder to do than say.

And reading between the lines, I would not be surprised if the cost of money here in Australia rose by up to 50% within the next five years.

As we wrote last week, there is potential downward pressure on the Australian dollar – which would generate an inflationary shock – thereby forcing the RBA to raise rates, despite still-weak economic growth.

Australia has offered higher interest rates to attract international capital in the recent past, but the yield advantage is disappearing as United States engages in monetary tightening while the RBA keeps rates steady.

Oh, and before I go, given it is Budget night, regardless of what the federal treasury labels debt, it still needs to be paid back – and looking forward, it will be increasingly hard for the Australian government to borrow cheaply – more so, if we keep piling on debt and lose our AAA rating.  We are now in a vicious circle.

This is another reason that the federal government proposal to try to stimulate economic growth (and keep unemployment down), by borrowing to fund a major program of infrastructure investment, needs reconsideration.

Keen to hear your thoughts.

Until next time,

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Michael Matusik

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