Money Minute – July 4 2017 “Rate Rise Coming?”

Rate Rise Coming?

The Reserve Bank makes an interest rate decision today. It will be on hold. In fact rates will be on hold for the remainder of this year.

Money markets say there’s just a 2 percent chance of a rate cut today.

But right now, it’s not rate cuts that occupies peoples’ minds, it’s rate rises. Today’s decision by the Reserve Bank is made against a backdrop of rising rates in the US. Canada’s also flagged rates could be going up. Even the UK, which has been a basket-case as it tries to work out its Brexit strategy, is considering when to raise official rates.

The reason rate rises are even being talked about has everything to do with currency. Generally, central banks and Governments want relatively stable currencies to encourage trade. A falling currency – generally associated with falling interest rates – is excellent for trade. The only problem is if that Government (or business) has large sums of foreign debt, it blows out when the dollar falls.

Conversely, a rapidly rising currency makes the foreign debt position shrink … but it hampers exports and encourages more imports to compete against local goods. As we well know … a higher currency creates a boom in offshore internet shopping.

The problem about the talk of a rate rise is – like buses – they never turn up alone. Like buses there are none, then there are three or four together.

But given the high level of indebtedness of Australian households … then interest rate rises are something many will potentially struggle with.

Investors – and even many households – have tried to stretch their borrowing capacity by using interest only loans. Already these loan rates are rising as  government, through the banks, tries to cool housing markets in Sydney and Melbourne (with these rules, I spare a thought for the poor blighters in Perth and Darwin, where property prices have been falling).

Through the futures markets, we get a hint about how money markets view possible rate rises. The so-called yield curve, shows expected rates over the next 18 months rising from one and a half percent – where the RBA has the cash rate now – to more than one and three-quarter percent in November next year. In other words, money markets are tipping rate rises in 2018

.

If it were one, or two increases, there’s little doubt most would cope with those rises pretty easily.

The problem is, especially with those home values in Sydney, Melbourne and Canberra … we’re among the most indebted households in the world. And when you have lots of debt … even relatively small rate rises start to hurt pretty quickly.

You can see here how household debt’s skyrocketed in the past 25 years, compared with our incomes. It’s alarming and is one reason why economists from overseas warn about Australia’s economy and our housing markets.

But the flip side of this is that while household debt have soared, so has our family wealth, which is now at record levels. Compared with those sky-rocketing liabilities our net wealth has soared by an equal proportion – even better.

That wealth is made up of financial assets (largely our superannuation funds) and dwellings (our houses).

Because those assets are largely illiquid (you can’t get your hands on your super until you stop work … you can access equity in your home, but it involves taking on more debt) even relatively wealthy households can have cash flow problems if and when interest rates rise.

Rising rates will make family budgets feel tighter … but if that cash-drag starts to slow the economy, it’s quite clear the RBA would slow the pace of rate rises.

In other words, you might be asset rich … but cash poor. And it’s never easy to eat your house.

But all this is in the future. For today, and probably six to eight months, the rates are likely to be on hold.

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