24 SEPTEMBER 2010

Interest Rates – Upside Down in Australia

Trying to predict the direction of interest rates in Australia over the next 12 months is always very difficult, with so many external factors having an impact.

Most Australians take a keen interest in interest rates, of course depending on whether you are a depositor or a borrower.

People investing in cash and term deposits have never had it so good, with introductory cash rates above 6%, and term deposit rates for six and 12 months between 6.0% and 6.5%pa.

People with mortgages are getting it pretty good at the moment as well, with discount mortgage rates down around 6.50%pa, and standard mortgage rates around 7.0%pa.

But we think we are going to see some significant changes in interest rates over the coming 12 months, for both depositors and borrowers.  The situation in Australia is just so strange at the moment, compared with the rest of the world, as our interest rates are significantly higher, partly because our economy has remained strong.

The official cash rate (such as the RBA rate in Australia) is currently as follows:

4.50%pa               -     Australia
0% to 0.25%pa     -     United States
0.5%pa                 -     United Kingdom
1.0%pa                 -     Eurozone
0.1%pa                 -     Japan

In Australia, our 90-day Bank Bill Swap Rate is 4.80%, with the market anticipating another increase in the RBA rate of 0.25% in the next three or four months, and 10-year Government Australian bonds are currently 5.14%.

In the United States, 10-year Government bonds are at only 2.57%, and in Japan, 10-year Government bonds are at a record low of 0.91%.

But why does Australia have relatively high interest rates when our economy is so healthy?

There is no question that Australia has quite low corporate debt, and very low Government debt compared to the other major economies around the world, but of course one of the problems in Australia is that we have a relatively high level of household debt, making Australian consumers (and mortgage holders) susceptible to even small interest rate increases.

Probably the main reason pushing up higher interest rates in Australia is the relatively high level of offshore funding to Australian banks which has become more expensive.

So what will happen with interest rates in Australia over the next 12 months?

We suspect some or all of the following:

• The RBA has pushed the official cash rate up to 4.50%, and indicated that interest rates are probably on hold for the short term, but the market is anticipating another 0.25% increase over the next three or four months.  We think there’s a chance that the official cash rate could rise to as much as 5.25% by the end of 2011.
• The incredible competition between the banks for new cash deposits and term deposits is likely to tone down over the next 12 months, and term deposit rates at 1.5% and 2.0% above the RBA cash rate is unlikely to persist.
• The Government guarantee on bank deposits (up to $1 million) expires in October 2011, and the four major banks will have a field day.  Depositers will be nervous to invest with second-tier banks, building societies and credit unions, when there is no Government guarantee.
• An article in the paper last week said that mortgage rates might get up to 9.0%pa within the next 12 months.  That’s probably a bit alarmist, but it’s almost certain that the banks will increase their margins on mortgage rates, irrespective of what the RBA does.  The four major banks have now got more than 90% of the new home loan market, and that will only increase, and the four majors will capitalise on their strong market position.
• Interest rates around the world are quite likely to remain very low for the next two or three years, and there will continue to be some downward pressure on interest rates, and we think a 6.0% rate for term deposits for a six-month term will probably be the top of the market.

We believe it’s almost a certainty that mortgage interest rates will go up between 0.5% and 1.0%pa over the coming 12 months, so if you’ve got a large mortgage, prepare for that.  And of course there is the risk that mortgage rates could go even higher.

Tony Gilham
Certified Financial Planner
Authorised Representative No. 230877

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