Are interest rates about to rise?

After a long period of record low interest rates in Australia, they’re predicted to start rising as soon as this year. What would an interest rate rise mean for you?

Interest rates have been extremely low in Australia – and in many places around the world – for years now. Rates began falling after the GFC, and then went even lower during the Coronavirus pandemic. Our official interest rate has sat at 0.1% since November 20201.

Central banks raise and lower interest rates to stimulate economic growth and control inflation. If inflation is high, they might raise rates to try to control it. If it’s low, they may lower rates to encourage consumers to spend and borrow money.

In Australia, we’re currently experiencing higher inflation than in recent years. The annual inflation rate reached 3.5%2  in December 2021, which is above the Reserve Bank of Australia’s target range of 2-3%. That’s one of the main reasons why economists are predicting there might be an interest rate rise as soon as this year. The booming property market is another reason.

So, are rising interest rates good news or bad news? It depends which way you look at it.

HOMEOWNERS AND FIRST HOME BUYERS


If you’re paying off a mortgage with a variable rate, you can expect your lender to increase this rate if the official interest rate goes up. This means the minimum repayment amount for your loan that you pay monthly or fortnightly will increase as well. However, if your mortgage has a fixed rate, you’ll continue paying the same amount until your fixed rate period ends.

There’s some good news for people who are trying to save for their first home. An interest rate rise can sometimes slow the growth of property prices, which have surged all around Australia over the past year. It might also make it easier to save a deposit, because a higher interest rate could mean you get a better return on your savings. However, a higher interest rate can also impact your borrowing capacity, because lenders will assess your ability to repay the loan based on that higher rate.

INVESTORS


Interest rate rises have an impact on all types of investments to varying degrees:
  • Shares. While share markets tend to react to political and economic news, like interest rate movements, any volatility is usually short-lived. As long as the economy remains strong, shares have historically performed quite well during periods of rising interest rates,
  • Property. Direct property and property securities can be impacted by rising interest rates because they tend to reduce the borrowing capacity for investors and borrowers. Higher interest rates can also slow down the property market by reducing demand.
  • Cash and fixed interest. Fixed interest investments, like bonds, may also be impacted if long-term interest rates rise as well. In this circumstance, this generally causes the price of existing bonds that are paying a lower interest rate to fall. This can cause low or negative returns for fixed interest investments over the short term.

 

SUPER MEMBERS AND RETIREES


If your super is invested across several asset classes – like Australian shares, global shares, property, fixed interest and cash – an interest rate rise could make your super balance go up or down, depending on how it’s invested. This might be a good time to review your investment strategy to make sure your portfolio is well-diversified and appropriate for your stage of life.

Rising interest rates might actually be good news for retirees. That’s because as people near retirement, they often change their investment strategy so they have a higher allocation to defensive assets – such as fixed interest and cash – and a lower allocation to growth assets – such as shares and property. The logic behind this is that once you get close to retirement you have less time to ride out short-term fluctuations in the share market, so having a lower allocation to high-risk assets means you’re likely to experience less volatility overall.

While this still holds true in a low-interest rate environment, the problem is that the returns for cash and fixed interest investments are closely linked to the official interest rate. If it’s extremely low, like we’ve seen over the past couple of years, then super or allocated pension returns can be very low as well. This can sometimes affect your retirement goals.

Therefore, if interest rates rise, retirees with their retirement savings invested in defensive assets may see an improvement in their returns over the longer term.

ARE RISING INTEREST RATES CAUSE FOR CONCERN?


While they certainly generate a lot of news, interest rate rises generally aren’t cause for concern. Central banks will take a broad view while recognising individual people and companies will be under high stress.

When it comes to super, keep in mind that it’s a long-term investment that will inevitably go through all sorts of market conditions over the years – high interest rates, low interest rates, market downturns, market booms. It’s part of the lifecycle of investing. However, if you’re concerned that your super isn’t properly diversified, or if your investment strategy isn’t appropriate for your stage of life, the best thing to do is speak to a financial adviser. They can help you determine whether your super is still on track to reach your financial goals.

WE’RE HERE TO HELP


Your Pinnacle Advisor is here to assist should you have any questions or concerns about your financial goals.

 

1. Reserve Bank of Australia, Cash Rate Target, February 2022

2. Australian Bureau of Statistics, Consumer Price Index, December 2021

 

Source: Colonial First State