Here's how record-low interest rates could affect your finances

Photo by Mark Metcalfe, Getty Images

The Reserve Bank of Australia has held the cash rate at 0.25 per cent for the second time since it cut the rate twice in March 2020.

Interest rates are set to stay lower for longer, with Westpac’s chief economist Bill Evans anticipating the RBA to hold the cash rate at this level until “at least December 2023”.

Why did the RBA hold the cash rate?

It was widely expected that the RBA would leave the cash rate as it is at its May meeting, mainly because it’s too soon to say that the economy has bounced back from the shock caused by COVID-19.

In a historic move, the central bank made an emergency rate cut in late March 2020, after already slashing the rate to 0.50 per cent two weeks earlier. This was done to keep people in jobs and stimulate the country’s economy.

Dr Lowe made it clear that the RBA would not increase the cash rate until Australia’s labour market moves closer to full employment and inflation is in the target range of between 2 to 3 per cent.

Fast forward to May, RBA governor Philip Lowe believes “globally, financial markets are working more effectively than they were a month ago”.

But he acknowledged that things aren’t back to normal just yet. 

In the RBA’s baseline scenario, or the scenario the central bank considers most likely to play out, Australia’s economic output will fall by about 10 per cent in the first half of 2020 and by about 6 per cent over 2020 as a whole. Growth will leap back by 6 per cent in 2021.

The RBA also reckons the unemployment rate will peak at about 10 per cent in coming months and will remain above 7 per cent at the end of next year.

He noted that the economy may recover stronger if the coronavirus is contained in the near future and we can return to business as usual sooner.

But if restrictions are kept in place for longer and confidence among households and businesses remain low, the outcome may be worse than the RBA’s projection.

What does a low cash rate mean for Australians?

Maintaining this low interest rate setting could have long-term impacts on the finances of everyday Australians.

For those who are more financially secure, a lower for longer environment may help make it more affordable to take out loans to buy property.

While there’s a chance that some may misuse this opportunity to borrow more than they can afford, this might prove to be difficult as banks tighten their lending criteria.

It’s also likely that borrowers on variable-rate loans may switch to fixed-rate loans, given that the RBA is not expected to lower the cash rate any time soon, according to Westpac analysis.

A low interest rate environment doesn’t mean competition has stopped between lenders. RateCity analysis shows that 38 mortgage lenders have cut their interest rates on more than 500 housing loans since the last RBA meeting in April, despite no change in the official cash rate.

Among the lenders that did slash rates, the average cut was 0.45 per cent. For someone who was originally on the average owner-occupier variable interest rate of 3.46 per cent, that reduction could deliver yearly savings of $1,176, based on a 30-year loan paying principal and interest.

These cuts pulled down the average mortgage interest rate overall, including both owner-occupied and investor loans, which fell by 10 basis points to 3.42 per cent in the month to May 2020, according to RateCity data.

But not everyone can afford to pay off their mortgage now, despite the cuts. Some 320,000 Australians have deferred about $3.3 billion in home loan repayments for up to six months, Australian Banking Association data found.

For those relying on interest from savings and term deposit accounts in a time of economic uncertainty, their income may be hit hard as returns fall.

Savers may need to rethink how they invest their funds or find another steady source of income, with interest rates likely to stay lower for longer.

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